The U.S. Securities and Exchange Commission is considering altering the definition of "accredited investor." Brokerage firms and other securities sellers generally are permitted to sell private securities offerings, such as limited partnerships and many hedge funds, only to those investors who fall within the definition of an accredited investor. Many of the wide-scale investment fraud and Ponzi schemes that have taken place over the last five years have involved the sale of private placement securities that could be sold only to so-called accredited investors.
Understanding the Current Accredited Investors Rule
The current accredited investor rule permits sales of these risky securities to anyone with either more than a $1 million in assets excluding their home or income of $200,000 or more. The rule is premised on what we believe is the mistaken conclusion that anyone who meets these financial parameters is by definition a sophisticated investor. But the fact that someone has built up substantial savings really has nothing to do with their ability to understand complex investment products. By way of example, many home builders or other individual business owners are able to amass large sums of money as a result of their businesses that have nothing to do with securities. Those businesses do not provide the business owner with any education or level of sophistication regarding complex securities. Yet, because of the simplistic accredited investor definition, brokerage firms are permitted to sell complex and risky private placement securities to these business owners. And many of these business owners actually have no understanding of the true nature of the securities.
Change Could Include Definition of Financial Sophistication
The SEC is considering whether to incorporate into the accredited investor definition an investor's financial sophistication, rather than solely their assets. While this would be a more subjective standard that could be more difficult to evaluate, it would provide greater protection for investors. Importantly, the number of years an investor has maintained a brokerage account should not be viewed as a variable in assessing one’s investment sophistication. An investor could maintain an account for 30 years, never performing their own investment research or analysis and always relying on an investment professional for investment advice. It could be unjust for such an investor to be labeled as sophisticated. Similarly, the fact that someone has not maintained an investment account for a number of years does not mean they have not received education or training on complex financial matters.
Some may argue that a subjective standard for an accredited investor that incorporates investment sophistication could be too time consuming or costly for brokerage firms to engage in. But we believe that the protection of investors should be foremost in the SEC’s consideration of a new accredited investor definition. The fact that it may be more time consuming or costly for brokerage firms to abide by the standard is something that should not prevail over investor protection.
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