To sell securities to US investors, an issuer must fulfil the SEC’s registration requirements or qualify for an exemption. A common exemption or safe harbour is to sell your securities only to accredited investors — individuals with a net worth of more than $1m, or annual income of more than $200,000.
In the past, such deals could not be advertised publicly but, in 2013, the SEC removed the prohibition on general solicitation and advertisements of unregistered securities.
This, by design, excludes all but high income retail investors, ostensibly for reasons of financial prudence. But income is not a reasonable metric to determine the financial sophistication of an investor.
According to the US Bureau of Labour Statistics, in May 2016 there were 10 occupations with an average annual wage of more than $200,000 in the US. All 10 are jobs in the medical profession.
While GlobalCapital does not advocate completely unrestricted investing, excluding potential investors simply on the basis of income smacks of elitism.
Non-accredited investors are excluded from participation in private placements and sales of unregistered securities. This assumes that information provided for registered securities is of value to investors.
Disclosures of a company’s financial health might indeed be valuable, but only to those investors sophisticated and motivated enough to actually trawl through quarterly financial reports — unless the regulator is relying on professionals to do that and distill sufficient publicly available information for laypeople to make an informed choice. If that is the expectation, then this should be systematised. Otherwise, there is no guarantee that an investor is availing themself of available information.
But it depends on your view of the point of regulation. Should poorer investors be prevented from investing in unknown 'opportunities'? Or should all investors be allowed to take on whatever risks they want, but in limited quantities?
If the intention of the salary benchmark is to minimise the possibility of investors bankrupting themselves with failed investments, then a restriction on the percentage of your income makes sense at any level of income. Non-accredited investors are already subject to income-based limits on the size of their investments in equity crowdfunding products. There is no reason that accredited retail investors should not be subject to similar limits.
Or, better yet, since the SEC is apparently attempting to control for investor sophistication, it could require prospective investors to sit a test or acquire a licence.
The Financial Industry Regulatory Authority already administers a Series 7 exam for stockbrokers. A watered down version for non-professional investors would ensure a basic level of competence far more effectively than a salary limitation.
Such a scheme could pay for itself if prospective investors were required to pay a fee to sit their sophisticated investor exam. The SEC might avoid some of the administrative and logistical legwork by outsourcing it. It could simply establish a curriculum, then license other institutions to conduct training and exams.
Perhaps there is a case for the idea that those on incomes below $200,000 require additional protections but the present laws do not offer this protection.
While non-accredited investors are not allowed to participate in IPOs, they are at perfect liberty to buy early stage equity in a start-up and risk losing their entire investment under an equity crowdfunding scheme, or in any publicly traded shares, for that matter.
In the old days, it was reasonable to exclude retail investors from IPOs when an investment banker would only have time to call up those investors placing the biggest orders. However, in today’s world of platforms and e-bookbuilding, surely something can be worked out.
Non-accredited investors are not protected from equity investments. They are simply shut out from participating in first offerings and benefiting from the typical post-IPO pop.
In the cryptocurrency world, there is a parallel injustice. Only accredited investors can participate in most initial coin offerings, buying up tokens at a discount, but they can go on to sell their tokens to non-accredited investors.
Whether this is legal, according to some lawyers GlobalCapital has spoken to, remains a vexed question.
All sales of securities, including those in the secondary market, must either be registered with the SEC or included in some safe harbour exemption. But with crypto, for now, it appears that the some regulators are prepared to turn a blind eye.
The SEC is far from alone in maintaining an income qualification for accredited status. Canada requires net income of $200,000. The European Union requires a portfolio of €500,000. The UK, while it has a high net worth individual requirement, also provides a “self-certified sophisticated investor” designation, which suggests a degree of financial knowledge, although it is not open to everyone.
Investor protections are important, and some financial products are not suited to investment by anyone other than experienced professionals. However, the present rules are capricious. They prevent retail investors from taking opportunities but do little to protect them.
Prudent investment is good for the economy, and encouraging younger people and those with incomes of less than $200,000 to participate is no bad thing, particularly in times of low interest and growing economic inequality.
Financial regulators should do what they can to encourage economic participation across society. Taking a look at inegalitarian restrictions would be a good start.