SEC Modernizes the Accredited Investor Definition
sec.gov
sec.gov
There's no wealth-test that prevents a person from losing all their money in highly-leveraged investments - from real-estate to fancy public-market securities. (Over-leveraging into real estate is practically encouraged by public policy.)
There's no wealth test against putting all one's cash into gambling, which can be arbitrarily worse than even the riskiest non-fraudulent startup investment, depending on your choice of wagers. (Official state lotteries are among the worst games, with the most manipulative marketing - to a level of deception that would generate lawsuits & legislation if attempted by private actors.)
There's no wealth test before purchasing legal but addictive & judgement-impairing substances like alcohol & marijuana.
But if you want to put $5-$20K into a friend's business, or a business you know well, the SEC makes it hard unless you're already a millionaire. It's insanely paternalistic & economically destructive - a ghostly holdout from some bad experiences in another era, the 1930s, when the ranges of available information, experience, and alternative temptations were all tiny & quaint compared to the 2020s.
People in the '20s were literally mortgaging their house and car to buy stocks on margin en masse because they took in advertising and word of mouth that told them it was a good idea. You could theoretically also do that at a casino, but practically speaking that's not a big problem.
Look at the crypto hype-train that got latched onto by people who didn't do their homework on crypto, or the craziness of WSB on reddit. We are still capable of letting that happen today.
These things just haven't been challenged in the courts because those wealthy enough don't know or consider this is an issue, and people less wealthy aren't even exposed to these kinds of opportunities and probably also can't afford the court challenge.
I think there is room for a challenge and invalidation of the entire concept because the wealth test actually used to be different kinds of tests as recently as the 70s. Those were no good because it led to arbitrary discrimination by the brokers and companies. And now we are back to that because FINRA licenses are more standardized.
Can likely invalidate the entire concept with more recent case law such as spending is speech via 1st amendment, 5th amendment and 14th amendment equal application of laws in comparison to the wealth/access dichotomy as well as ability to speculate and gamble in other markets.
If one person can't pay their home loan for the month that's the borrower's problem. If millions of people can't pay their home loan for the month that's the bank's problem, and generally speaking that's enough to start bank runs.
* add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.
Looks like series 65 is the way to go since series 82 also requires sponsorship.
Depends. If simply passing the exam was enough, that does seem semi-reasonable. But if it requires you actually be licensed by your respective state, then the rabbit-hole goes much deeper. I looked at the requirements here in NC, although I don't know how representative they are of other states, but basically you'd have to register with the State as an investment management company (which would probably entail registering an LLC or something), and then pay them $300 / year to keep up your registration. Add the $200/ year or so for the LLC filing fees, as well as the paperwork requirements (annual report, etc), tax filings, and suchlike, and you're talking about a barrier that while not insurmountable, is still going to be fairly steep for most people.
More competence-evaluation – ideally constantly recalibrated according to the performance & satisfaction of those approved. Do some certifications/skills-tests strongly predict later competent investing? Increase their weights. Do others seem to be easy backdoors that lead to lots of burned investors? Decrease their weights.
Manage for the goal - wealth expansion & a vibrant private investing ecosystem – without the archaic oversimplifications "rich are competent to do whatever they want, and young/poor are incompetent so must be kept on a short regulatory leash".
Then, no competent poor person would be legally locked out of an investment opportunity, by state enforcement power, that would be legally-encouraged for any incompetent wealthy heir.
Requiring that someone has to be able to deliver the funds, sure.
Perhaps, that they have to prove competence via some testing certification.
Perhaps, that they have to match some scaled risk threshold, when relying on systemic benefits: we only give you tax-advantaged retirement accounts, or full unemployment coverage, if you don't put more than X% of your net worth in 'risky'/non-public securities.
Those would at least be objectively-linked to a person's abilities, or the magnitude of risks they're projecting on the community.
But wealth tests in state regulation codify a class system: "You can't buy this, even if you have cash-in-hand, even if you're an expert, even if the spillover risks are infinitesimal, unless you're already rich." Such discrimination against the poor should be just as illegal as that based on race, gender, national origin, sexual preference, religion, etc.
I qualify as an accredited investor based on net worth. I have invested in private companies, both through employee stock options and as a preferred seed-stage investor. However, I keep most of my funds in self managed brokerage accounts. I will not quote returns here, I am not here to boast, I'll just say I do beat the S&P by a significant percentage.
https://www.bloomberg.com/opinion/articles/2018-09-24/earnin...
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1. Anyone can invest all they want in a diversified portfolio of approved investments (non-penny-stock public companies, mutual funds and exchange-traded funds with modest fees, insured bank accounts, etc.).
2. Anyone can also invest in any other dumb investment; you just have to go to the local office of the SEC and get a Certificate of Dumb Investment. (Anyone who sells dumb non-approved investments without requiring this certificate from buyers goes to prison.)
3. To get that certificate, you sign a form. The form is one page with a lot of white space. It says in very large letters: “I want to buy a dumb investment. I understand that the person selling it will almost certainly steal all my money, and that I would almost certainly be better off just buying index funds, but I want to do this dumb thing anyway. I agree that I will never, under any circumstances, complain to anyone when this investment inevitably goes wrong. I understand that violating this agreement is a felony.”
4. Then you take the form to an SEC employee, who slaps you hard across the face and says “really???” And if you reply “yes really” then she gives you the certificate.
5. Then you bring the certificate to the seller and you can buy whatever dumb thing he is selling.
6. If an article ever appears in the Wall Street Journal in which you (or your lawyer) are quoted saying that you were just a simple dentist, didn’t understand what you were buying and were swindled by the seller’s flashy sales pitch, then you go to prison.
Someone will argue the language has some ambiguity and the lawsuit will impact the SEC for 'failing to protect the public'
The claw is how the next clerk knows you’ve been through the other line. That could replace the slap part of the process.
That is an exageration for publicly traded securities. It used to be possible (in the roaring '20s) to be 10:1 leveraged in public stocks. The SEC forbid that because so many people were wiped out. Nowadays retail stock accounts can under-perform, but it's a big deal when a lot of people see their portfolio decline by 30% -- think 2009.
People have gotten wiped out in large numbers on real estate. I just think it is an exaggeration to say people are taking huge risks with a normal stock account
Here's a recent news story: "20-Year-Old Robinhood Customer Dies By Suicide After Seeing A $730,000 Negative Balance"
https://www.forbes.com/sites/sergeiklebnikov/2020/06/17/20-y...
And I know your uncle can probably find a way to make a crazy risky investment. The idea is just to try and cut down on that to avoid systemic risk.
In terms of risk, it's important to consider the volatility of the underlying and the leverage ratio.
New home owners are taking on massive leverage on a new home purchase, but usually the low volatility of real estate protects them from too much pain.
Many of the people defending these 1930s-style regulations, as if these regs truly protected people from themselves, seem to also be stuck in a mid-20th-century view of what the investment & informational environment is like.
If someone is truly gullible & risk-seeking, any amount of capital can be destroyed in any number of legally-approved investments/gambles, almost instantly. The 'Accredited Investor' rules just lock the less-wealthy out of one small and not even especially risky corner - a place where the less-wealthy could potentially better-deploy local knowledge. So this old rule is now just paternalistic friction, without any real personal or systemic wealth protection.
Public companies have regulations that help prevent such fraud by requiring things such as audits by third party accounting firms, and regulating how these audits may be performed. Such regulations came about specifically as the result of fraud committed by the owners and directors of companies.
Private markets don't have these regulations because the assumption is that past financial success is indicative of financial sophistication. It doesn't prevent fraud, but at least it helps reduce the likelihood of success.
If you start making private markets open to everyone, then there's no reason to differentiate between public and private markets anymore. Companies will go back to all being "private" because there are fewer regulations, then there will be another Enron, and a subsequent shift towards regulation to prevent another such scandal.
Couple this with 401Ks now giving retail investors (likely high-fee) choices to invest in private equity[1], and the picture looks much more volatile as the next generation draws closer to retirement.
[1] https://www.latimes.com/business/story/2020-06-19/private-eq...
Controlled substances (ie: prescriptions,)
Pretty much any consumer safety or mandatory licensing law.
Even something as simple as buying a beer - we insist that legal adults are not allowed to buy a beer until they are older.
We insist that adults must be over 21 to buy a handgun in many states, or that (in other states) they must show that they are sophisticated gun owners by passing a firearms safety course.
We let people with special licenses and training (pharmacists) buy opiates openly, yet deny individuals the right to do so without receiving written permission.
We don't allow non-specialists to buy certain kinds of explosives, but we allow others with credentials to do so. The same applies to all kinds of things, up to and including varieties of river frogs (!).
We insist on documented "informed consent" for things like surgery, again to protect vulnerable people from bad actors.
We don't let adults buy many kind of fireworks out of fear that they will harm themselves or others, yet if someone can prove (through obtaining a license) that they are competent, we let them buy and fire huge commercial fireworks.
In short: there are an enormous number of similar restrictions. A lot of them exist because the previous state (no law) caused enough damage that restrictions were added.
We didn't have rules, then something extremely bad happened to make people say, "that should be illegal." So it's made illegal. A generation passes and young people look at said regulations, think, "that's a stupid rule," and they revoke it. Goto 10.
Investments that require you to be accredited are often pretty bad ones. All the great opportunities get cherry-picked by those with the right networks. What most people will be investing in are the scraps that all the smart investors passed on. That's how accredited investors get burned and go back to boring old index funds.
If you open these markets up to average Joes, it's going to be a bloodbath. Fox News will switch from running ads to invest in gold to ones for scam companies with fraudulent books. Elderly women will get hounded by phone salesman. We'll go back to the way it was in the 80s.
The problem with caveat emptor is society as a whole gets screwed as well. We all get to live with the economic collapse brought on by the situation.
It is absolutely not true of every nonsensical paternialistic nonsense Congress has passed.
Example: Median returns across venture capital are net-negative, even if expected value is net-positive:
https://techcrunch.com/2017/06/01/the-meeting-that-showed-me...
The effect is even more extreme for early-stage startups given the power-law nature of returns.
See the concept of "Chesterton's fence":
> In the matter of reforming things, as distinct from deforming them, there is one plain and simple principle; a principle which will probably be called a paradox. There exists in such a case a certain institution or law; let us say, for the sake of simplicity, a fence or gate erected across a road. The more modern type of reformer goes gaily up to it and says, “I don’t see the use of this; let us clear it away.” To which the more intelligent type of reformer will do well to answer: “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.”
* https://www.chesterton.org/taking-a-fence-down/
First determine and be able to explain why something was put in place. If you cannot explain why, you have no right to tear it down. If you can explain the original reason, you may then be able to explain why it may no longer be needed.
This raises the question of whether a similar system could exist for investments. Do you think there could be a "prescription" investment where you'd need a sign-off from someone with certain qualifications who'd consider your financial position and what you were planning to do?
What if you had to be rich - far beyond the sticker & insurance price - to buy a car? ("You're not a millionaire? We've decided you should only be allowed to take the bus.")
Rich to buy a beer? Rich to buy a gun?
Rich to buy a bunch of OTC medicines? (Poor people would still need a prescription - from a doctor, or perhaps, under the "rich makes smart" standard, just a rich sponsor.)
Rich to buy fireworks?
Rich to buy certain books, with dangerous knowledge? (Similar to how it is only by private investing that you get a full practical education in how such investments/firms work.)
An entity paying – actually forgoing other possible expenditures of the same money, as in this example Medicaid or some other 3rd-party payor – should have some level-of-control. There's a budget constraint in effect - other priorities they are responsible for will suffer if this one is chosen.
But anybody, regardless of wealth, for whom it's important enough to scrape up the costs can skip that hurdle, in your example. There's no extra legal burden, of thousands of dollars of costs, added by the state just because they're poor. There's no extra complications the government forces onto the counterparty – the doctor – just because the patient is poor, thus deterring the otherwise-mutually-desired activity from happening at all.
(Of course, there are such complications if Medicaid actually pays – hence many doctors avoiding Medicaid-reimbursed patients/treatments.)
And in the end the poor patient still gets the treatment - unlike the permanent freeze-out of unaccredited investors – unless & until they bank $1,000,000.
Say a consumer protection law that prohibits an appliance company from selling me a cheap heater that isn't up to code. That law restricts the appliance company's freedom, but it also restricts my freedom to contract with the appliance company. The law is restricting my freedom to protect me.
(Personally, I'm fond of Matt Levine's "stupid investment license" proposal, but I would not be in favor of an "unsafe heater" license)
Your example still sits within finance.
They're arguing that you shouldn't have fineprint that says "if you only let millionaires sit at your table, you can use loaded dice"
Third party certifiers could (and many believe would) emerge as trusted testers. For example, if you own a casino you can request certification from the "Fair Dice Association." They can then certify that your dice are fair. I as a consumer know they're reputation, and I trust their due diligence.
This also has the benefit of utilizing free-market competition to drive down costs and ensure quality. It also avoids granting an authorization of violence, which some people believe is wrong whether it's a "government" or not.
This isn't purely theoretical. It already happens. SOC 2 certification from the AICPA is a great example.
This isn’t purely theoretical. It has happened repeated in recent history. Arthur Andersen signed off on obvious accounting fraud at Enron due to conflicts of interest. During the GFC, credit ratings companies graded low quality MBS derived securities as ‘triple A’ without bothering perform anything beyond a cursory examination.
Now imagine what would happen if every rando could start playing in the private markets. Well you don’t have to imagine too hard, we did a natural experiment not long ago with crypto currencies. What did we get? Shameless pump and dump schemes organised openly on social media, pyramid schemes, vapourware ICOs, and all manner of other dodgy dealings.
One reason these scams were so hard to stop was that so many unsophisticated scammers and scammees people were involved. The wealth requirement at least reduces the numbers of people involved to a somewhat manageable level. I do agree though, it’d be nice to have a more equitable way to do this. I think this action from the SEC is an important step towards that as it now opens the doors to qualified people that might otherwise fail the wealth test.
That's fine. But you first up the enforcement and second decrease the qualifications.
I can tell you from personal experience that the SEC has a lousy record of enforcement against even serial bad actors. And the civil system is even worse.
4 of 9 startups that I have been involved with have had criminal levels of malfeasance and have gone to court and lost--however, that didn't win anybody any money. And the SEC was nowhere to be found. Perhaps I'm just bad at picking startups, but anecdata from my friends suggests that I'm batting better than most and that the fact that they got judgments against them is the unusual part and not the 50% having malfeasance.
Story time of the worst: worked for a startup that had the usual friends and family investment structure. A couple dozen people all at $50K-$100K. No big deal.
Came in to do technical work. Okay, once I got there it was clear that everybody was out of their depth and the work was going to be significantly more than expected. Not unusual, and I'm working hourly with some number of hours defrayed by stock options if I think the idea is useful.
Start down the path. CEO is spending money like water on marketing. That's not unheard of and probably not even a bad idea.
The CEO then gets a "lawyer" from Silicon Valley who attempts a maneuver to take control of the company from the investors without buying them out.
And here come the lawyers.
So, of course, at this point, a chunk of us demand both the financial records as well as the documents behind the maneuver. Denied, so we need to compel the request.
And, of course, once we get the documents, we find that the company has been bled of nearly $1.5 million in cash in what were later found to be illegal arrangements.
Off to court we go. So, what are your options?
You can sue individuals, but that means piercing the corporate veil. You can force the company into bankruptcy, but if you're found against, you can wind up with a big penalty on your hands. You can report to the SEC, who basically ignore you because this simply isn't worth their time to bother with ($10 million is the minimum to even get them to call you back).
And through all of this, you will be spending cash to your lawyers while the opposing side is spending investor cash to fight you. Or, in this instance, has cut a special deal with the "lawyers" by giving them a "retainer" of $300K and now is doing work "for free".
Oh, by the way, the clock is ticking. If you don't push the company into bankruptcy soon, that "retainer" can't be clawed back because it will be outside the time window.
Fine. File a suit to force payment due and force them in bankruptcy.
The opposing "lawyer" shows up and his sole job is to delay while doing nothing. The judge even finds in your favor and admits that he has no sufficient way to penalize the company or the lawyer. And likely won't penalize the lawyer anyway because the court system protects its own--even the scumbags.
And, by the way, a significant cohort of the investors are VERY upset with you. They like the con-man, after all. So, you aren't crusaders for justice; you're interlopers who upset the apple cart.
And, if you're vulnerable, you may get a suit launched against you by the company for "reasons". Yes, it's a nuisance and you will win, but it will cost you even more money.
The moral is: We probably would have been better off to simply let him keep stealing money from people, cut a deal for some level of payment and just walk away.
THIS is the reality you are championing for. Just so you know.
I understand the current reality. I was in several startups myself, and got caught up in this sort of thing.
When I said:
> You go hard and strong after the bad actors
there is a lot wrapped up in that statement. Not just having more SEC involvement. More like doing whatever it takes, all the way up to refactoring our entire financial system and going after wall street and the federal reserve.
I understand that sounds unrealistic, but the financial class are mostly parasites IMHO, and will eventually kill the host if something is not done. It boils down to class warfare, which the accredited investor BS explicitly reflects.
There will also be liquidity differences--even with a broader set of investors--between private and public markets. Thus if a company wants to have liquid equity (which benefits employees) they will need to be public. Additionally, many large institutions have caps on private market investments which are generally smaller than public equity caps. I don't see this changing given liquidity concerns, going public will still be the road to access more institutional capital.
Lastly, your Enron example exemplifies the point that fraud will occur, regardless of private or public markets (and regardless if it is audited by an established third party accounting firm. Arthur Anderson signed off on Enron for years, at it took years for a big 4 accounting firm to recognize the fraud committed by Wirecard). On the flipside, public markets have regulatory requirements which make it easier to research, but just because private markets don't require disclosures doesn't mean there is no information to go off of. Investors can still get enough info to make reasonable investment decisions without disclosures following public company requirements. This gives investors the ability to make their own decisions regarding which disclosure standards are sufficient instead of differing to the SEC. In fact, I believe that Private Markets would experience less fraud if the only requirements were education based and not net-worth based,
Books and records inspections are expensive for both issuer and investor. For the issuer, it almost always requires legal counsel be retained.
If a company wants to raise private capital from retail investors, the JOBS Act created Reg A+ [1] for them.
[1] https://en.wikipedia.org/wiki/Regulation_A#Regulation_A+
"Specific statutes in the California Corporations Code provide shareholders the right to inspect bylaws, accounting books, records, minutes and financial statements. The California Corporations Code allows the court to enforce these rights."
In my mind it is like the NYPD making it illegal to walk down the street at night unless you are 6'2" or above, or have trained in martial arts. After all, there are a lot of people out there who would want to take advantage of a weaker, easier target. And it also just happens to make the NYPDs job easier.
I don't know how any of this works but my kneejerk reaction is Maybe private markets should have these regulations as well? If a company can't follow these regulations maybe they have no business raising cash in the first place.
The idea that the SEC should limit access to hedge funds, private equity, and startups is antiquated. A modern approach could simply put the burden on the entity seeking investments. Access to investors with net worth less than $100k could simply require extensive disclosure. Many people would lose money investing in things they know nothing about but this would not be meaningfully different from our current situation.
That's not all that different from how it works now. Most of the difficulty of public listing is the higher level of disclosure required.
Over the last 90 years we have repeatedly learned very difficult lessons about the individual and societal costs of unregulated securities markets and made changes to mitigate those risks. And this same tired argument comes along, repeatedly, to justify rolling those regulations back so that a handful of people have a chance at striking it rich while we as a group learn those same difficult and expensive lessons all over again.
Our securities markets work. They are predictable, mostly fair, and most importantly, they are trusted. Are all of the rules perfect? No. Do some of the rules and regulations have compliance costs that outweigh their benefit? Of course. There is plenty of room for improvement and we should absolutely identify the areas in need of modernization but you’re advocating we tear the whole house down when you haven’t made an effort to understand why it was built this way in the first place.
According to what standard? Is the fact that I can’t invest $5000 in my friend’s startup an example of our securities markets “working”? Not according to any rationally justifiable standard.
Certainly the impulse to protect grandma’s life savings from predatory fraud is a good one. But the proper way to better society is through empowering individuals to make better decisions. An example of a better system along this principle would be a local (county/state) investment office that you go through that checks over the terms of the deal to make sure the terms are legal and the parties are fully aware of what they’re getting themselves into. That would protect against fraud, without violating my right to freely and consensually associate with other consenting adults. “Others might do a bad thing, therefore you should be banned from doing a good thing” is not a logically coherent standard — yet that is the essential argument of the SEC and it’s “accredited investor” protections.
Your view that these markets are “working” is merely an indication that you lack imagination. How much better would the world be if there weren’t arbitrary restrictions on economic exchange? It’s impossible to know, but history shows that advancements in liberty and justice have breed unprecedented wealth.
Not quite that onerous. But the start-up and investor would each need to spend at least $5,000 on legal diligence. This would likely be true with or without the rule—if you don’t understand the preferred investors’ terms, you aren’t qualified to invest.
You absolutely don't need to do disclosure like a public company if you have non-accredited investors.
IANAL. Hopefully your founder friend will have had a startup attorney to ask about all of this.
No. That is not remotely close to summarizing the SEC’s stance on accredited investors or the regulations the SEC enforces to protect retail investors. The securities regulations are, at their core, a disclosure regime. They aren’t intended to police for bad investments and they aren’t intended to prevent you or I or anyone else from making stupid decisions with our money. They’re merely about how much information must be furnished to potential investors before they invest. That’s it.
If you want to sell securities to everyday folks, they have to be registered. Full stop. Any unregistered sale is an exemption to the rule but anyone can register their securities for sale and provide potential investors with a prospectus and some basic information about the investment.
Generally speaking the registration and disclosure requirements are eased or exempted for people with a higher income not because they’re smarter and can avoid bad investments or because they’re better situated financially to absorb the loss. It’s because they have the resources to do the diligence and hire people ask the questions and get the necessary information to make the investment. Think of it as outsourced compliance. Rather than the entity paying for the cost of registering the securities and everything that entails the investors pay for it up front.
And that makes sense. If I have a question about Apple’s prospectus I can’t ring Tim Cook and ask for more information. What you see in the disclosures is what you get. But if I’m one of the 35 unaccredited investors in my friend’s company and I have a question I can absolutely call the CEO and get the answers.
And now think about the middle ground: JFrog, for example, before they filed their S-1. If you or I invested $5,000 and we had a question about operations do you think we’d get answers? No way. If Elon Musk invested and he had the exact same question do you think he’d get answers? Of course.
And then mostly dismantled those changes, in an environment when financial entities have more reach and capital to spin into dubious schemes than ever before. What could possibly go wrong?
I had an OMG experience trying to look up a very interesting non-public software company on SharePost a week ago. They will offer me a chance to buy something. I don't get any clarity on the cap table, so I'd be completely in the dark on preferences, dilution, etc. I'm being asked to offer a price range before seeing any trading history. And there's no availability (at first) of any financial history.
There's potential here to make a uniquely bad investment in what might be a uniquely great company. We won't cry a lot of tears for rich people who make some bad investments in the dark. For people living closer to the edge, having them get fleeced has spillover effects that are ugly enough to argue against letting it all play out with total laissez-faire.
Especially if lax rules invite the hustlers to overwhelm the market. (Gresham's law)
The problem is the cost of doing diligence. Not investor competence.
In public markets, the cost of producing reports on the issuer. In private markets, almost by definition, it's on the investor. Each investor must thus have the resources, legal at a minimum, to evaluate an opportunity.
Given these resources have a high minimum cost, an investor of limited means is faced with two options: forego the opportunity or gamble. When the latter is chosen, it doesn't just hurt the investor per se. It creates a fecund field for fraud, seedstock for scammers. (To say nothing of the fact that when retail investors lose money, it has social and systemic effects in a way that someone who loses 10% of their portfolio on a failed start-up investment does not.)
I agree that there might be room for a friends-and-family exemption. But private companies should not be allowed to solicit, directly or indirectly, retail investment dollars.
What do you mean? Individuals are still allowed to sign contracts. So write up a specific contract.
But mixing in any 'unaccredited' investors drives up the legal complexities and costs, through extra liabilities. A generous (or desperate) founder might still go through the extra headaches to take money from a wider circle, but many potential knowledgeable investors are encumbered and essentially frozen out, simply because they are sub-millionaires, due to extra legal hurdles. It's like everyone who's not a millionaire is a minor, not trusted to contract like an adult - but not based on age or competence, just net worth.
Millionaires face no such restrictions – and thus enjoy the state's support in preserving for themselves privileged, first-look access to a class of potentially-lucrative investments.
It'd be like if millionaires were granted their driver's license on request, because hey, they can be trusted. And we'll waive their fees for permit applications, because they surely hired good advice before applying. Car registration, marriage license? Free if you're rich, we know you won't be getting into any trouble.
But you're not a millionaire? Find a rich sponsor willing to be a counterparty, and pay extra fees, because you poor folks are just too risky to [drive, build, marry, etc].
And yes, people who have years worth of expenses saved are clearly better able to accept risk than someone with $10K in an IRA.
You're not making persuasive arguments here at all. An in both theory and in practice I'm on your side.
It does not ask if you have legal counsel. Indeed, even being an investment-specialized, bar-licensed lawyer yourself, drafting agreements upon which other 'accredited investors' depend, wouldn't make you 'accredited'!
But having $1,000,000 in the bank would. Prior wealth.
Several now very-rich, even 'celebrity' tier investors have mentioned that they simply faked the accreditation at a crucial early stage.
Of course, there's survivorship bias in such stories. But I feel like a sucker for not doing that - and thus losing money in approved things like NASDAQ instead. Or being over-concentrated in my own risky projects – which no SEC rule can protect a person from! – where other private investments would've been usefully uncorrelated.
I could've survived a 100% loss in whatever dozen or two startups I might have taken a flyer in – but in fact, they wouldn't have all cratered, and even if they did I'd have had far more insight into investing, and a broader network, than otherwise. Instead, that valuable experience was reserved for the rich, and those willing to lie about their riches.
So who is this rule protecting, exactly?
The masses now are most certainly just as, if not more, susceptible to fraud now then they ever were. Then people were literally selling stock certificates on the street, now people line up like sheep to be lead to the slaughter and fight their way to the front.
This may be celebrated like a much needed deregulation, but this was pushed by some deep pocketed special interests that can’t wait to give the unemployed masses the ability to day trade right from their phones.
1. permitting natural persons who have "professional certifications" or "credentials issued by an accredited educational institution".
2. include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund.
Most of the other changes fill in gaps that shouldn't have existed: expanding the definition of spouse and adding orgs with >$5MM assets (including tribes, family offices, etc.). YC relevant: "demo days" will not constitute a general solicitation.
Overall a welcome change. I assume that they'll use an existing set of professional certifications in finance, which tend to require non-trivial self-study, so it'll probably also create a market for short educational programs offered by accredited institutions.
And if getting an accredited-institution MBA, for tuition payments of anywhere from $22K to $200K, after about 17 years of other education (K-12, undergrad) isn't enough for someone to protect their own wealth from scams, what's the point of all that credentialing, anyway?
The same pattern exists for law and many other professions. There are plenty of people with law degrees who fail, or decide to not pursue the bar exam.
And an MBA who's not a millionaire isn't competent to do any private investing, even with just a small amount of their own money?
Why should their net-worth be legally dispositive?
So why not let anyone take a proportionate risk?
IMO: A real MBA with an emphasis on finance probably should count as sufficient education. An executive MBA definitely should not. Although a program with the same structure as an executive MBA but exclusively focused on finance, accounting, and contracts might be reasonable.
But ultimately we'll need to wait for the final list.
As just one example, stories pop up every few years about sheriff's offices selling 'honorary deputy' or similar status to rich people. I guess sometimes people buy them as symbols, but more frequently for the concealed-carry rights.
On the other hand, I could participate in sh*tcoin ICO’s, get rich quick “courses”, and become a real estate “investor” by attending presentations at a Holiday Inn conference room.
The law as it currently stands, does not work, period.
I’ve been prevented from investing in the funds and businesses of my high integrity friends, while being allowed to participate in lotteries, gambling, MLMs, ICOs, the list goes on...
I was really hoping this would be a huge announcement, but unfortunately its a couple tiny steps towards the ultimate end goal of opening up private markets to individuals.
Many people like to reference scams that this law helps avoid, but I call BS.
Has it limited some cons from raising money from middle class people, yes. Has it limited a lot of middle class people from participating in areas with the highest returns, yes.
I’ve read about several people that weren’t accredited checking the box anyways, and no enforcement actually happens, which makes me think it’s a BS regulation to begin with.
It's ironic that Russia today is more capitalist than the US... It's like both countries lost the cold war against each other.
This is exactly what the Soviet political elites did to keep living the good life at the expense of their poor citizens; all under the pretext of protecting people from themselves.
That's because it's not a prohibition on individuals as it wouldn't be constitutional. It is a prohibition on issuers, who can face civil and criminal sanctions while also having the entire offering rescinded retroactively. The government effectively achieves what they were going for either way. (A strategy to curb/steer any behavior is to regulate the intermediary.)
So if you, the individual, want to lie and constructively get into a private offering and be quiet like an actual wealthy investor, there is no consequence except you might overextend yourself due to the minimum investment amount set by the issuer.
Regarding law, the government can still place any number of restrictions on issuers, but the current law does not work and I think it can be argued that it "chills speech", and doesn't make sense. Always remember, the entire SEC is a creature of the New Deal, and although this is heralded in our history books, most of the new deal was quickly declared unconstitutional, and the rest wasn't challenged. Here we have something that doesn't affect rich people and they might not be aware of it, while issuers are prohibited from marketing to poor people and poor people generally aren't aware of it either. There are just a few upper middle class people that get to say "what the heck is this"
I get the gut feeling that the SEC doesn’t have the audit capacity to focus on the likely smaller deals where non accredited people lie.
Please share any cases you’ve found
Companies and individuals get fined and sanctioned for non-exempt offerings of securities all the time all day every day.
Non-exempt means that the issuer either didn't bother to care, or tried to comply with a registration exemption but failed. One way of failing is the inclusion of non-accredited investors. Depending on the exemption being leveraged.
No sanction will say “aha we found non accredited investors” it will just say the exemption wasn't used correctly.
Sometimes its just a fine.
Sometime the sanction is proper registration and financial reporting like a publicly traded company has to. This is often a death knell to small issuers due to the time and expense of ongoing compliance as well as unsavory information that deters future investment, which is why so much energy goes into avoiding it, even in VC backed companies which now aim to go public at the end of their growth cycle.
And in egregious cases the company and individuals behind it will have a criminal securities fraud and wire fraud charge.
Its not because a “poor person” lied. You really have nothing to worry about.
where are those published?
https://www.sec.gov/page/litigation
I dont think SEC reports all
All states have an equivalent agency
CFTC gets involved sometimes and there are some capital offerings and issuance solely under its purview
If you are looking for that you are looking for the wrong thing. If you are on the fence about trying to qualify for a private investment because "law" its not your problem.
But if you are issuing an investment, it definitely is your problem.
Sorry man, not everything that occurs and why it occurs is on Google for your independent review. You just have to talk to people, and lawyers, and come to an average-right conclusion.
Maybe there is some blog somewhere about someone talking about their fine from the SEC or a case study, but its unlikely because people don't want to out themselves like that, or typically settlements (in general, not necessarily with regulator) bar people from talking about them.
I’m fairly sure a place I worked at had this problem, and it held up funding for a long time.
A VC won't bail from a compliant offering because they checked people on the cap table that said they were accredited at the time, they will bail because there are a lot of people on the cap table to begin with.
This change sounds like a good one but there's not enough information to know if it will really open up any opportunities for regular people.
Do you know why the SEC created these rules? If you understand the history it makes a lot of sense.
It's easy for HN to say "this makes no sense", but I guarantee you if the rules changed we'd see some article in the NYTimes where some retiree lost their entire life savings in a private investment including quotes like "no one told me it was that risky".
You're arguing we should have a social safety net so when some blue collar worker loses 100% of their retirement savings because they invested in a scam start-up, they're covered?
The market operates efficiently when every entity involved can have net worth of any amount, including negative. Unfortunately, human life requires a particular amount of wealth to survive. You cannot have a pure free market system without there being some left out. The purpose of government is to protect rights to life, liberty, and property. That means providing some support when someone's wealth is so low that they cannot sustain their life.
This should be implemented in such a way as to affect the market least. Milton Friedman's negative income tax would be one possibility, but there are others as well.
In any case, the market should be free to operate as if the person could reasonably be expected to have nothing.
If you want to look at a modern example of such things, consider the cryptocurrency ecosystem and the many scams that occurred [2]
1 - https://en.wikipedia.org/wiki/Wikipedia:Chesterton%27s_fence
These "are you rich enough?" limits, on just a few classes of potential investments, did not and can not provide any protection against rampant risks like:
* Enron (an audited public company approved for widow-and-orphan investing)
* Madoff
* Fake-documentation or risk-oblivious home lending
* At-home Forex or securities trading in arbitrarily exotic or leveraged ways (Robinhood! Futures! Expiring options!)
* State lotteries with awful odds & deceptive advertising preying on the decision-biases of the poorly-educated
* Prosperity gospel solicitations
So rather than proving the value of Accredited Investor restrictions, your example scams (some crypto), and others, just show them to be an ineffectual symbolic Maginot Line, not a wise Chesterton's Fence.
Things like enron cooking the books, or madoff ponzi schemes are going to happen regardless of the accredited investor certification.
But what you can't know is whether having early stage startup and other investments require accredited investor certification means fewer people get trapped into investments they don't fully understand. I think it does.
How many people reviewed the Enron disclosures? How many amateur daytraders & Robinhood investors read all the disclosures of the "public" securities they hop into and out of?
Aren't all levels of investors leveraging the greater attention of a smaller group of experts? Couldn't some non-millionaires – there are a lot of them, with many diverse skills! – be the kind of highly-attentive 'leads' who help vet firms for larger networks?
Is an inherited-funds millionaire, no matter how dumb or lazy, more immune from the risks of non-disclosure than a young & ambitious non-millionaire? How about a non-millionaire with graduate degrees in business, finance, law? Why not test competence, not net worth?
Would you also only allow the high-net-worth to do other risky activities, like drive private cars, play contact sports, camp on public lands, visit the beaches?
How about raise children? There, a life is at stake. Do we dare let these gullible, barely-adult non-millionaires, the kind of rubes who would throw all their money away on unwise private investments if the SEC didn't save them, have children?
And if slick founders can easily fleece these childlike non-millionaires through deceptive promises, what chance do these wisdom-constrained individuals have against slick politicians? Is it really prudent to let non-millionaires vote?
I don't think it's easier for an average person in the 2020's to differentiate between investments, risky investments, and outright scams than the 1920's, were all the regulations to be waived away.
The Panic of 1929 was far from the first crash of the 1900s, let alone the only large crash in history. The Panic of 1893 would have been the big crash that everyone was afraid of before 1929, but there were more minor crashes in 1901 and 1907. Railway manias and land speculation-driven crashes litter pretty much every decade of the 19th century. The 21st century is unusual because it's pretty much the first time in modern financial history you make it an entire decade without some sort of recession.
I'd argue the crypto currency and ico hysteria of late proves otherwise.
These rules are generally based on the residence of the investor, not their citizenship. I'm an American in Quebec currently, and it's the Quebec/Canadian rules which determine my eligibility to invest while I'm living here, not the SEC's. And in Canada's case, the accredited investor rules are broadly similar to what the US rules were before this announcement, with the same dollar amounts but in Canadian dollars and with a lot of other differences in the details.
You don't get disclosures attached as an accredited investor, that's the whole point.
Here's a good analysis of why more people didn't go to jail: https://www.theatlantic.com/magazine/archive/2015/09/how-wal...
Lack of successful prosecution doesn't mean that illegal activity didn't occur. Are you ticketed every time you drive over the speed limit? I'm not.
How exactly does a PhD in Biology help you understand investments?
Based on this evidence and many similar cases, I'm entirely in favor very stringent rules on who gets to place big bets on financial securities.
__________
0. https://en.wikipedia.org/wiki/Madoff_investment_scandal#Affe...
A fundamental understanding of the primary scientific literature and patents necessary for a technology to be viable, can all be used to determine if a new technology will be profitable for a company, beyond the scope of overall risk and investment numbers. Both of which are used extensively in graduate research.
Recent insane volatility could allow you trade from a couple thousand up to 25k in a few weeks - BUT you will most likely run out of day trades before that happens.
It's highly annoying.
[1] https://www.bloomberg.com/opinion/articles/2018-09-24/earnin...
[1] the paragraph starting with "A better approach might be to lower (or eliminate) the wealth bar for investing in private placements"
I've had the chance to see a lot of investments that require you being an accredited investor. Almost all of them have had some highly problematic issues. Most of them have a outcomes where you can lose all of your money and there is NO WAY to get out of the investments.
What I tell other people is run away from investments that require you to be accredited.
Seed round investments are probably the "best" opportunity BUT you have the risks of being screwed by cap table games. A "regular" person could put money into a startup and get really screwed.
It really doesn't matter how much of a genius you are at recognizing investment wins. If you can't give them enough cash to finance their operations for a significant period of time, the company isn't going to be interested in taking your money. If you can't meet the wealth guidelines, you're not gonna be able to give them enough money to be worth their time dealing with.
EDIT: It's not $60, but $175, still a far cry from a million.
The easiest path this opens for someone not in the securities industry is to become a state registered investment advisor. In my home state of Illinois, that would require paying $400 a year to the state and $150 a year to FINRA, as well as subject you to a number of non-trivial regulatory requirements.
I just reread the new accredited investor final rule, and as per footnote 102, people who qualify via Series 65 need to maintain in good standing a state-granted license or registration. No other requirements exist on top of that.
Is this work... yes. But the capital requirements are so low that it broadens access to many more people. I'd expect companies to start forming around getting people their Series 65 and allowing them to affiliate themselves with the business for a fee. This is still significantly better in terms of accessibility than the $1million wealth requirement or income >$200k.
If it is a "sure-fire win", then individuals don't get to participate in those investments, institutions and people with a lot more money than you have get to participate. As an individual of only moderately high worth, you get the shit portrayed in the movie Boiler Room.
Which is why whining about accredited investor rules annoys me: they can change the rules, but that isn't going to make companies want to deal with your small potatoes. They're not knocking on your door now, why would a rule change make any difference? Even if you cross the magic threshold, opportunities will not immediately knock on your door out of the blue. But if you want dents in your door from all the knocking, up your net worth from single-digit millions to double-digit.
Great news for small investors! And a vital change for minority and marginalized communities, who are often forced to seek capital outside their community, because it is incredibly difficult to meet accredited investor requirements otherwise.
https://financialpost.com/personal-finance/managing-wealth/s...
People working in the industry know that self-certified means lie through your teeth all day every day with a straight face.
People working in the industry know that you can create illiquid investments, trade one unit of it and say you own the rest at the same price, and viola you are a multimillionaire. I did it with crypto assets 6 years ago using Counterparty.
People working in the industry know that you just need a lawyer or CPA to sign off on that.
The prohibition is on the companies selling securities, not on the investor, so the company just needs a way to cover their ass (CYA) and there is no consequence for the investor. "Self-certification" is a code word for lying, or stretching the truth, just checking the box.
In your experience how willing are CPAs or lawyers to do that for you?
In theory they're putting their credentials on the line for you, so I imagine it's either hard to find ones that will do that or very expensive to the point where it eats into the investment return with the amounts of capital being invested below the accredited investor limit.
There have been a SaaS services for this the whole decade, and that’s only because the issuer exemptions were expanded to even need a lawyer because an investor saying “yeah Im accredited” wasn't good enough for some securities issuance exemptions.
You don't lie to the lawyer (or most lawyers), you show assets. Assets which so happen to have a value and are totally illiquid. You trade a single unit of something you create for $1 and you happen to have 2,000,000 more units. You’re accredited by any standard. No different than your portfolio of houses in a place nobody wants to live in, which still happen to have appraisals totaling over $1mm.
If that doesnt feel “right” to you then you might be confusing who actually has the consequence here and might have been unproductively conditioned to “follow the letter of the law” compared to the consequences and implementation of the law. Again its a prohibition on the securities issuer which they pass on to the investor. Its not a prohibition from the government on the investor or the lawyer. And the securities issuer simply has to go through the motions. Check, check and check. And the investor has to pony up the cash. If they don’t have the $25K or $100K minimum anyway then get out. The government’s role in this is just a redundant deterrent.
My curiosity is about that conversation with the lawyer when you say "I traded a single unit of something I created for $1 and I happen to have 2,000,000 more units." where something is cryptocurrency (what else could it be?).
Would most lawyers go "Yep, just another routine accredited investor check, $200 please."
Or would most say "I'm being asked to affirm this person has $1m in assets and in the off chance that somehow this is checked by someone I could be penalized because I didn't do my diligence to make sure this isn't just funny money".
if they start predictably acting like non-accredited investors after jumping through those hoops, then there will be more scrutiny.
right now not enough people that are actually poor jump through those hoops. there are a lot of people liquid with $25k-$100k or can get it, that don't make $200k/year or have $1mm in assets when not excluding their home. the wealth requirements also don't account for cost of living by area. Some of them jump through the hoops to get access to things they really should have access to. The rest don't and poorer people can't because the investment minimums so that nobody's time is wasted is too high.
So it makes more sense to have various lower risk investment vehicles that are attached to those markets -- like if real estate is booming in your part of the world, then it should be possible to create some kind of investment group where 100 people put together their money and buy various properties.
Allowing people who don't know much about options to buy them in a leveraged position is incredibly risky for tons of reasons. Many people's understanding of options is basically like if the stock goes up, then the call option that is above the current stock price goes up -- the option price could easily could go down if the expectation was that it would go up even more than it did, or the price volatility decreases! Not easy to explain all of the horrible ways you can easily lose money in the markets... I've sometimes thought, maybe I should just do the opposite of everything I've thought I wanted to do.. maybe that'd be better than what I'm doing..
It's honestly laughable that their top priorities in the height of what appears to be a massive stock bubble is weakening investor protections at a time when they should be strengthened
Mostly, this is about hedge funds, not startups. "Accredited investors" can invest in hedge funds that don't report their returns publicly in a standard way. Usually they don't report them because hedge funds as a class underperform the Dow.
Useful rule: any investment where they call you is no good. If it needs paid salespeople, it's a dud.
It's all for their own protection of course. We really care about the peasants. Especially when they bail us out.
So... now people who hold a couple of niche, finance industry specific licenses - which you can't obtain unless you work in the finance industry - can be "accredited investors." Wow, golly gee whiz, color me gobsmacked.
So finance industry insiders get more access to opportunities to build wealth, and nothing changes for regular old everyday Americans? Am I supposed to be impressed by this?
The ONLY way this would actually be worth trumpeting would be if anybody could study, sign up for, take, and (hopefully) pass the various FINRA exams mentioned, and get their license without needing to go to change jobs. But, sadly, as we see here[1]:
Candidates must be associated with and sponsored by a FINRA member firm or other applicable self-regulatory organization (SRO) member firm to be eligible to take FINRA representative-level qualification exams.
and here[2]:
In order to enroll for FINRA qualifying exams, a candidate must be sponsored by a state regulator or regulatory authority approved to sponsor candidates for FINRA qualifying exams.
Edit: there is some verbiage here[3] that claims that you can take the Series 65 exam without being associated with a member firm. IF true, I might change my opinion on this a bit. But this seems to contradict what is on the FINRA site itself.
Unlike many other FINRA Series exams, the Series 65 exam does not require an individual to be sponsored by a member firm. If you are not Form U4 registered or affiliated with a firm through FINRA’s Web CRD system, you should use the Form U10 to request and pay for the Series 65 exam.
[1]: https://www.finra.org/registration-exams-ce/qualification-ex...
[2]: https://www.finra.org/registration-exams-ce/qualification-ex...
[3]: https://www.kaplanfinancial.com/resources/career-advancement...
VC follows a power law and the vast majority of these investments will fail.
It looks like the current certifications are restricted to those of financial professionals [1] and employees of funds [2]. That doesn't strike me as nuts.
[1] holders in good standing of the Series 7, Series 65, and Series 82 licenses
[2] natural persons who are “knowledgeable employees” of the fund
Yes, I would like to read Matt Levine rip this apart.
After specifying that "holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons," the bullet point adds that the SEC chose this "approach [to provide] the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future."
So no, at this point, only holders in good standing of those licenses are included in this part of the amendment.
$200k/year may be "relatively low" in certain areas, but it borderline unattainable in many parts of the country.
People can be smart, and perfectly capable of understanding the risks with offerings in their own industry, without making 200k/year. Don't automatically discredit people with airquotes based on their salary alone.
There are also many people who make more than $200k/year who are, quite frankly, not "financially sophisticated enough to take on the risk".
Matt Levine has it right- just peg the total amount of investments in these sorts of vehicles to 10% of cash, stocks, and bonds, until the investor crosses the $X million dollar mark.
Upper-income households (double the national median) account for 20% (side note: yeah, we have a yawning wealth gap). Those household incomes are $207,400 in 2018. So I'm not going accept your 3% number.
https://www.pewsocialtrends.org/2020/01/09/trends-in-income-...
> Upper-income households (double the national median) account for 20% (side note: yeah, we have a yawning wealth gap). Those household incomes are $207,400 in 2018. So I'm not going accept your 3% number.
You are comparing two different things, so your objection is invalid.
Also, as noted elsewhere, part of this change was to expand what incomes in the household count towards the accredited investor threshold. Some number of those households didn't qualify because some portion of their household income didn't.
Even the SEC commissioner's have pointed out this incongruency.
The only thing supporting this difference is that gambling is regulated at the state level, while securities are regulated by the Feds with a few exemptions so that states feel like they have power. Spot commodities and uncategorized property are ignored by both.
Smart people that are not born into a useful amount of money have to earn and hope absolutely nothing goes wrong for decades, while being cut out from many growth opportunities, but they are able to speculate in many other financial games anyway. There are plenty of smart people that were earning where nothing was going wrong, until suddenly the pandemic sent them back to their parent's house where they will stay for the next decade.
This dichotomy in opportunities wasn't an issue when the equities sector was structured differently. Before the 21st century, companies were going public much earlier and much more frequently. There simply are not Microsoft's and Amazons going public at $37 million valuations anymore.
So now it is an issue.
I really don’t know what you are talking about anymore. Turn down the trolling. Congratulations if you have enough money not to care what others are going through. Try not to discount the luck involved in that.