Will Congress Expand Pool of Investors Eligible to Participate in Private Offerings?

A Key Senate Committee is Considering Legislation that Would Expand the Definition of “Accredited Investor”…

A key Senate committee is considering legislation that would expand the definition of “accredited investor” and allow businesses to market private offerings to a wider pool of investors. The Fair Investment Opportunities for Professional Experts Act is part of a package of bills dubbed “JOBS Act 3.0,” which aims to spur capital formation.

The House of Representatives passed the package of bills by a vote of 406-4 in July; however, the legislation died in the Senate. Now, the Senate Committee on Banking, Housing, and Urban Affairs is considering several of the bills, which have been revived in the new session of Congress.

Accredited Investor Definition

The definition of accredited investor has remained essentially the same since 1982, when it was enacted as part of Regulation D. It provides that a natural person qualifies as an accredited investor if he or she has individual net worth – or joint net worth with a spouse – that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person. Alternatively, an investor satisfy the threshold  if he or she has income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

The accredited investor standard is important to both businesses and investors because it sets the bar for which investors can make an informed investment decision and protect their own interests in the absence of the protections of the Securities Act of 1933. Given the level of risk, federal and state securities regulations restrict many private securities offerings to accredited investors. Notably, a company may sell its securities to an unlimited number of accredited investors, but can only sell its securities to up to 35 other purchasers in reliance on Rule 506 of Regulation D.

The Dodd-Frank Wall Street Reform and Consumer Protection Act directed the Securities and Exchange Commission (SEC) to review the accredited investor definition, citing that the current financial thresholds fail to account for decades of inflation. While there is a general consensus that changes are needed, progress has been slow.

Fair Investment Opportunities for Professional Experts Act

The Senate Committee on Banking, Housing, and Urban Affairs recently held a hearing on the Fair Investment Opportunities for Professional Experts Act. The legislation would amend the Securities Act of 1933 to modify the definition of “accredited investor” for purposes of participating in private offerings to include: 

• An individual whose net worth or joint net worth with their spouse exceeds $1 million (adjusted for inflation), excluding from the calculation of their net worth their primary residence and a mortgage secured by that residence in certain circumstances; 
• An individual whose income over the last two years exceeded $200,000 (adjusted for inflation) or joint spousal income exceeded $300,000 (adjusted for inflation) and who has a reasonable expectation of reaching the same income level in the current year; 
• An individual who is licensed as a broker or investment advisor by certain entities; and 
• An individual determined by the Securities and Exchange Commission (SEC) to have qualifying education or experience.

The Securities Industry and Financial Markets Association (SIMFA) is one group publicly supporting the bill. “Financial professionals are uniquely well-suited to evaluate the risks and merits of prospective investments, and access to accredited investors is critical for private businesses unable to access public capital markets,” SIFMA wrote to the Committee. “Unfortunately, the current definition of accredited investor relies on net worth thresholds for individuals and households irrespective of the sophistication of the would-be investors. By excluding individuals whose professional experience or financial knowledge qualifies them to purchase restricted securities, the current standard unfairly limits Americans’ participation in capital markets and should be amended.”

In his testimony before the Committee, Thomas Quaadman, executive vice president of the U.S. Chamber Center for Capital Markets Competitiveness, called on the SEC to explore additional ways to expand the accredited investor definition.

“We believe it is appropriate to put in place requirements and tests that correctly define persons who have the sophistication to put their money in complex vehicles and have the ability to withstand losses,” he said during his testimony. “Traditionally this has been done through asset and income tests. The issue with using assets and income to determine who is accredited is that the rule can be both under- and over-inclusive at the same time: It can leave out a sophisticated and savvy investor who may not meet the financial thresholds, while including a wealthy person who has no experience whatsoever in the financial markets.”

Regulation Best Interest

During its hearing, the Senate Committee on Banking, Housing, and Urban Affairs also addressed Regulation Best Interest, another controversial measure. Regulation Best Interest would require broker-dealers to act in the best interest of their retail customers and clarify the fiduciary duty owed by investment advisers to their clients.

The SEC is scheduled to take final action on the proposed rule by September 2019. However, Sen. Sherrod Brown (D-Ohio) expressed concerns during the committee hearing, citing a comment letter written by 11 former SEC officials. The officials argued that Regulation Best Interest had “weak and incomplete economic analysis,” which could affect American families. “That warning should be a red flag for this committee,” Brown stated. “We should call in the SEC to explain.”

If you have questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.