Don’t Raise Accredited Investor Thresholds
The gulf between Securities and Exchange Commission (SEC) Chair Gary Gensler’s rhetoric and the results of his leadership continues to widen. In interviews and speeches, he claims to be trying to help working families, yet he pursues policies that thwart their ability to climb the economic ladder.
Bloomberg reported recently that the SEC may raise substantially the accredited investor (AI) net worth threshold, currently set at $1 million. Accredited investors, because of their wealth or other sophistication criteria, may invest in private companies in ways others may not.
In December, the SEC indicated it would review the threshold “to more effectively promote investor protection,” in a little-noticed regulatory agenda document. The scope of the proposed change apparently just became known. The Commission will seek public comment in April.
The problems with this proposed change are many. First, it would reduce opportunities for both investors and entrepreneurs. Most startups, especially in scaling industries like technology, seek investment first from AIs under Regulation D 506(b) (Reg D). Raising the bar for qualifying as an AI means less startup funding. It also would have disproportionate geographic and demographic consequences, falling hardest on regions and entrepreneurs already struggling for funding.
In the United States, wealth and access to capital are largely concentrated in a few elite coastal zip codes, where custom and relationships limit access. Raising the accredited investor threshold would further solidify these venture capital meccas as the only places where new ideas get funded, as described in a recent SEC Small Business Capital Formation Advisory Committee, which recommended expanding AI criteria.
The Commission should follow that recommendation and liberalize private market investing for everyone. The AI restriction excludes most Americans from participating in startup funding that carries higher risks but could generate much high rewards than the limited investment options currently available to them. University of Georgia Law Professor Usha Rodrigues calls this securities law’s “Dirty Little Secret”:
The dirty little secret of U.S. securities law is that the rich not only have more money—they also have access to types of wealth-generating investments not available, by law, to the average investor. …
[C]urrent law … discriminates on the basis of wealth, as a proxy for sophistication, or the ability to fend for oneself. Securities law thus in theory, as in practice, marginalizes the average investor without acknowledging that it does so, let alone justifying it.
In practice, the rich get richer via access to the most promising companies at their earliest stages, where growth prospects and massive returns are greatest. Raised thresholds would mean that even fewer people would have the chance at building generational wealth.
Raising the AI threshold would also stymie the entire private investment market. The only way retail investors can currently play in the private markets is through Regulation Crowdfunding (Reg CF). In March 2021, the SEC loosened some Reg CF restrictions to make it more attractive. One move was to remove the investment cap for AIs. This allowed small money to follow smart money into Reg CF. In other words, an AI could place a big bet on a startup and lots of retail investors could join that bet on the same terms. Raising the AI threshold will mean startups will get less traction with big investors and retail investors won’t benefit as much from large investor due diligence.
Supporters of tighter restrictions, like some state attorneys general and the North American Securities Administrators Association, justify raising the AI threshold based on the misdeeds of some fraudulent issuers. But that claim fails scrutiny. Most private investment is done by AIs through Reg D and Rule 144A. These two markets dwarf the public markets which raised $1.2 trillion in 2019. By contrast, that same year Reg D alone outpaced the public market (registered offerings) with almost $1.5 trillion. These numbers would be impossible if investors feared fraud.
The crypto revolution has also refuted arguments restricting the private markets. The Commission recently settled with virtual marketplace BlockFi for $100 million dollars. As Commissioner Hester Pierce notes, BlockFi had always paid out its promised returns so it is hard to say who Gensler was trying to protect. If the end result is savers receiving anemic rates instead of the large returns of BlockFi, working families will clearly lose.
In fact, crypto shows the folly of artificially restricting anyone’s ability to invest in legitimate assets of their choice, as explained by podcaster Nathan Whittemore:
[W]e need to be a lot more careful about who we view as someone who needs protection. In the [Elizabeth] Warren-Gensler mindset, anyone who is not an institutional investor needs to be protected. That may make sense to Gary who made $120 million off his time at Goldman and in other parts of the very, very walled gardens of traditional finance, but it simply isn’t the case, when “retail” spent the last decade kicking the ever-loving s**t out of institutional investors in one of the biggest wealth creation moments in history. Maybe we think a little bit before we lump all retail investors into some paternalistic bucket of little guys who need protection. In fact, it is the first time in history that this was possible because crypto’s permissionless nature inherently obliterates barriers to entry. In other words, the first time in history that retail investors weren’t structurally pushed out or denied access to an investment opportunity. They completely beat nearly every professional investor to it.
Under Gensler’s leadership the SEC has sought to “promote investor protection” with nary a thought to its utility or secondary effects. The result has been a dismal record on crypto and a constant push for more power that do nothing to help the people Gensler purports to protect.