Monday, February 27, 2017

SEC Wants All Investors to Access High Risk Investments.

In a startling about-face, Acting Securities and Exchange Commissioner Michael Piwowar called for allowing every investor to buy unregistered securities, regardless of their income, net worth, or ability to suffer the risk of loss.

The Issue

The discussion arises in the context of investing in private placements. Private placements are securities offerings of unregistered securities - they are not registered with the SEC and are generally not reviewed by any regulator before they are sold. Many of these offerings are high risk and the securities sold are typically illiquid.

It is because of that risk that companies are limited in who they can sell and solicit for these investments. Those restrictions generally work out so that firms do not accept investments from investors who are not "accredited." There are a number of types of accredited investors, but for individuals, they much have an annual income of $200,000 or more or a net worth of $1 million excluding their home. 

The accredited investor definition attempts to identify those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves remove the necessity for the protections of the '33 Act's registration provisions. While there are problems with the definition, the concept is sound. At the extremes, Bill Gates does not need to be protected in the same way your retired schoolteacher grandmother might be. 

Allowing companies to raise money without the costly registration process is fine - so long as the investors know and understand what the investment is, and what those risks are. The accredited investor definitions focus on financial information, and maybe a better test would be a review of actual investing experience, or maybe an investment test to qualify those sophisticated investors?

For now we are left with a financial test, which requires a balance. A narrow definition limits the number of investors and restrict the potential investor pool for business. A broad definition, would remove individuals who need the protection of the registration process, and would be nconsistent with the Commission’s investor protection mandate. It would also violate a basic tenet of the Securities Act by failing to provide investors in need of protection with adequate disclosures before they make an investment decision.

The Accredited Investor Definition

The definition of an accredited investor was introduced in 1982, and has not been changed, despite the effects of inflation over the years. However, the Dodd-Frank Act required the SEC to review the definition every 4 years.

The trend at the SEC is to limit the number of individuals who meet the requirements of an accredited investor, and, in theory, protect the investing public. For example, in December 2011, the SEC amended the definition to exclude the value of the investor's home, resulting in fewer investors meeting the net worth standard.

In December 2015 when the SEC Staff reviewed the definitions and made a number of recommendations, including the creation of new, additional inflation-adjusted income and net worth thresholds and to index all financial thresholds for inflation on a going-forward basis.

The SEC Chair's Comments

However, those changes may soon be coming to a halt. In a speech at a Practising Law Institute conference in Washington, Mr. Piwowar said that the restrictions on who can participate in private placements limits the returns and portfolio diversification of investors who are not defined as "accredited."

According to, Mr. Piwowar said "[i]n my view, there is a glaring need to move beyond the artificial distinction between 'accredited' and 'non-accredited' investors," Mr. Piwowar also said. "I question the notion that non-accredited investors are truly protected by regulations that prevent them from investing in high-risk, high-return securities available only to the Davos jet-set."

While the definition certainly limits the investment choices of non-accredited investors, the reasoning behind the restriction remains sound. Or does it? It seems that Mr. Piwowar is claiming that the registration requirements of the securities laws for securities offerings do not do enough to protect investors. 

While I agree with him, that the registration requirements do little to protect investors and are a huge burden on small businesses and broker-dealers, is the answer to simply abandon investor qualifications and allow anyone to invest in high risk private placements? I like the concept of removing some of the paternalism that is inherent in the securities regulation web, but is this the position that the SEC should be taking? 


As InvestmentNews noted, democratizing the sale of unregistered securities can make investors with less financial werewithal vulnerable to losing money on the often risky ventures. Every review by the SEC Staff and Advisory Committees have recommending tightening the accredited investor definition, not removing it.

But here is Mr. Piwowar recommending changes to that Grandma can put her life savings into the latest technology private placement. Not a smart move by any stretch of the imagination.