By Laura Anthony, Esq.
On July 19, 2016, the SEC Advisory Committee on Small and Emerging Companies (the “Advisory Committee”) met and drafted its recommendations and response to the SEC report on the definition of accredited investor. The subject of changes to the definition of accredited investor has been debated in a series of reports, recommendations, proposals and comment letters since early 2015.
On December 18, 2015, the SEC issued a 118-page report on the definition of “accredited investor” (the “report”). The report follows the March 2015 SEC Advisory Committee recommendations related to the definition. The SEC is reviewing the definition of “accredited investor” as directed by the Dodd-Frank Act, which requires that the SEC review the definition as relates to “natural persons” every four years to determine if it should be modified or adjusted. See my blog HERE on the report and additional background on the subject.
At the July 19 meeting, the Advisory Committee finalized a draft of a letter to the SEC outlining its recommendations on changes to the definition of accredited investor. The Advisory Committee had previously submitted a letter to the SEC on March 9, 2015, on the same subject; see my blog HERE for details.
The Advisory Committee made five recommendations related to the definition of “accredited investor,” each of which I support fully. In particular:
- The core of prior recommendations remain the same, with the added statement that “the overarching goal of any changes the Commission might consider should be to ‘do no harm’ to the private offering ecosystem”;
- The SEC should not change the current financial thresholds in the definition except to adjust for inflation on a going-forward basis
- The definition should be expanded to take into account measure of non-financial sophistication, regardless of income or net worth, thereby expanding rather than contracting the pool of accredited investors;
- “Simplicity and certainty are vital to the utility of any expanded definition of accredited investor. Accordingly, any non-financial criteria should be able to be ascertained with certainty”; and
- The SEC should continue to gather data on this subject and, in particular, what “attributes best encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”
Advisory Committee Considerations in Support of its Recommendations
The Advisory Committee Letter lists practical facts and realities related to small business and emerging company capital formation in support of its recommendations. In particular:
- Emerging companies play a significant role as drivers in the U.S. economy, including supporting innovation and job creation. The ability of these emerging companies to raise capital in unregistered offerings is critical to the economic well-being of the U.S.
- The exemptions under Regulation D are the most widely used transactional exemptions, resulting in $1.35 trillion of raised capital in 2015, which amount is comparable to capital raised in registered offerings;
- The accredited investor definition is the centerpiece of Regulation D and is intended to “encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”
- Currently a natural person is an accredited investor if they have (i) earned income in excess of $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or (ii) a net worth in excess of $1 million excluding the value of their primary residence.
- If the individual and net worth thresholds are raised significantly, it would considerably decrease the number of households that qualify as accredited investors. This decrease would disproportionately affect areas with a lower cost of living, which areas already coincide with regions of lower venture capital activity. Moreover, a decrease in the accredited investor pool would have a disproportionate effect on women and minority entrepreneurs.
- The Advisory Committee notes that it is “unaware of any evidence suggesting that fraud in the private markets is driven or affected by the levels at which the accredited investor definition is set.”
Note: Original appeared on Legal & Compliance, LLC on 2 August 2016. Click HERE
Securities attorney Laura Anthony is the founding partner of Legal & Compliance, LLC, a corporate, securities and business transactions law firm. The firm’s experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances.
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