In yet another example of the disconnect between economic reality and government policy, the SEC has put out an Investor Education tweet on the topic of Accredited Investors. Suffice it to say that we remain unimpressed.
In September, new rules eliminated the prohibition against general solicitation and advertising on certain private offerings – for regulatory geeks, offerings made in reliance on exemptions under Rule 506 of Reg D, and Rule 144 of the Securities Act of 1933. This affects such offerings as hedge funds, private equity or venture capital funds, and the direct offering of certain privately-held securities.
Exempt private placements provide investors less information than IPOs and other publicly traded securities, and they often offer illiquid securities or otherwise higher-risk investments. The private placement exemption relies largely on the investors being more risk tolerant and savvier than the average stock buyer – and wealthier. And of course neither the issuer nor the SEC is responsible for providing investors with an analysis of the varying success rates of the broad range of private offerings, which cover everything from hedge funds participations, to seed capital for start-up ventures.
Under the rules permitting general solicitation these offerings will continue to be available only to Accredited Investors – the wealthier ones, remember. What’s missing from the mix now is the previous gatekeeper requirement that the offering entity, or its placement agent, have a pre-existing relationship with the individual investor. The theory was that investors would be shown deals that were appropriate to their situation, and the placement agent or adviser would take into account the individual’s overall financial picture, risk profile and other unique aspects of their situation.
We will not dive into the debate about whether this is a good idea – or, as some have called it, “open season” on unsuspecting individuals. But we note that the fuzzy economics of the Accredited Investor standard pushes more of the risk in these investments lower on the investor food chain.
The release provides the following definition:
“An accredited investor, in the context of a natural person, includes anyone who:
- earned income that exceeded $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
- has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
On the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse.”
The big change in the definition, as the release points out, is that under Dodd-Frank the value of the investor’s primary residence has finally been excluded from the net worth calculation. This means, hypothetically, you could lose your summer house in the Hamptons to pay an equity call in a private equity fund, but not your pricey co-op hovel on Manhattan’s Upper East Side.
The release goes on to provide a sample template to help you calculate your net worth, to see whether you qualify to invest in one of the new hedge funds or venture funds that will soon be plastering banner ads across Twitter. For our nickel, if you need an SEC release to teach you the concept of net worth, you probably don’t qualify to invest in anything (except maybe a third-grade education).
When the general solicitation rule first came out back in September, we went after the Accredited Investor standard. Once more, for good measure: the standard covers individuals with $200K in annual income ($300K jointly with spouse) or $1 million in net worth. This financial standard was introduced in 1982. The only change to the financial test for Accredited Investor is the removal of the primary residence form the net worth calculation. The baseline net worth test, though, has not. As we noted back in September, the 2013 equivalent of one million 1982 dollars is over $2.4 million.
This means that the SEC has actually increased your buying power in one key area: you can now purchase lots more risk for one million dollars than you could in 1982 when the standard was first introduced. We recognize that the Commission is not traditionally home to high-level “quants,” but even without a degree in differential calculus you can see that your dollar now buys nearly two and one-half times the risk it did in 1982, for no greater likelihood of return.
This dismal message is brought to you as a public service – something the Commission wasn’t able to provide.