Don’t Raise the Accredited Investor Threshold; Change the Approach

Following a demand of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 , the Securities and Exchange Commission (SEC) will consider whether to lift the income and net worth requirements for accredited investors later this year. Some advocacy groups think the present levels are too low to give protection to investors from fraud and risk of loss and are pushing for a rise.

Rather than just evaluating the present thresholds, the SEC should consider limiting the quantity somebody can spend money on “ a single, nonpublic securities offering ” to a collection fraction of his or her net worth. Such an approach would boost the volume of capital available to personal companies, establish consistency with proposed equity crowd-funding rules, encourage investor diversification, and permit ordinary Americans to co-invest with the rich. More importantly, it might keep those in Washington from falsely assuming that wealth measures investor sophistication, or offers much protection against fraud or loss.

In setting its rules, the SEC must balance investor protections with capital availability. Shifting to a hard and fast-investment approach would increase the variety of those who could invest in private companies, making more capital available to these businesses. Even within the pre-crowdfunding era, surveys showed that there have been nearly 8 non-accredited informal investors for each accredited informal investor. The ratio is probably going larger today.

The change also would make the non-public placement rules according to the SEC’s proposed equity crowd funding rules , which enable non-accredited investors to invest in private companies through online portals, subject to annual caps at the share of income and net worth they’re permitted to take a position. Using a set-investment standard for equity crowd-funding, but a financial threshold standard for personal placements makes little sense if both activities involve efforts by private companies to sell equity to individual investors.

A fixed-investment methodology would also motivate investors to raised diversify their portfolios. Under the present financial threshold rule, nothing precludes investors for placing all in their money (less the price in their homes) in shares of a single private company. That loss of diversification places investors at substantial risk of loss. a hard and fast-investment standard may well be designed to force investors to widen their holdings, which might better protect investors.

Shifting to a hard and fast-investment-approach would also reduce inequities within the current system. Financial thresholds create groups of “haves” and “have-nots” that keep people with less money from co-investing with the “one percent.” By barring average Americans from making an identical investments because the best-off, the present system perpetuates unequal access to financial opportunities.

A fixed-investment method would end the false premise that financial thresholds protect investors. “Dollar thresholds have never been a correct proxy for investor sophistication,” the North American Securities Administrators Association (NASAA) recently wrote to the SEC. Because current thresholds were set with little consideration as to whether they represented the real sum of money that investors could afford to lose, adjusting them upward for inflation merely makes them inflation-adjusted arbitrary cut-offs.

Financial cut-offs do little to give protection to investors from fraud. Fraudsters even might be prone to target the wealthy because the financial returns to fraud are higher when the targets have extra money. Collectively, wealth does little to enhance a person’s fraud detection skills. Lots of those duped by master fraudster Bernie Madoff were accredited investors several times over.

A fixed-investment-methodology meets the goal of defending investors, while avoiding most of the negatives present with financial thresholds. In place of just considering whether to boost the present accredited investor cut-offs, the SEC should reconsider its entire approach.

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