We previously discussed the SEC’s decision to allow businesses to solicit accredited investors and what this could mean for the growth of companies in Florida. Now, the SEC is weighing whether the definition of ‘accredited investor’ needs to be amended in the context of continuing to guarantee the health of start-up and other companies and their impact on our economy.

On March 4, 2015, the Securities and Exchange Commission Advisory Committee on Small and Emerging Companies approved its written recommendations regarding changes to the SEC’s definition of “accredited investor.” ^[1] Every four years starting in 2014, the Dodd-Frank Act requires the SEC to review the definition of “accredited investor,” as it applies to natural persons, to determine whether it should be modified for the protection of investors, in the public interest and in light of the economy.^[2] Since the SEC amended its private placement rules in 2013 to allow companies to engage in general solicitation of investors and advertise their private placement offerings, there has been increased focus on whether the SEC should change the definition of “accredited investor.” Any changes to the definition could have dramatic effects on the private securities markets and the general economy by significantly increasing or decreasing the number of persons who qualify to invest in the private securities markets.^[3] To put this in context, more than $1 trillion was raised in private placements in 2013, as compared to $1.3 trillion raised in public offerings in the same year.^[4] As noted in the Advisory Committee’s recommendations, since a majority of net new jobs in the United States is generated by companies less than five years old, their ability to raise capital in the private securities markets is critical to the well-being of the United States.

Many proponents for increasing the dollar thresholds for an individual to qualify as an accredited investor argue that such increases are necessary to prevent fraud against investors who may be unable to fend for themselves. However, the Advisory Committee notes that the connection between fraud and the accredited investor thresholds is tenuous at best. In fact, the Advisory Committee found that there is no substantial evidence that the current definition of accredited investor contributes to fraud or that it has resulted in greater exposure to victims of fraud. Furthermore, the Advisory Committee found that there is substantial evidence that the current system works and is critical to supporting privately held businesses and smaller public companies (i.e., those with less than $250 million in public market capitalization). Consistent with these findings, the Advisory Committee’s first recommendation to the SEC is that the SEC’s primary goal in reviewing the definition of accredited investor should be to “do no harm” to the private offering ecosystem and, accordingly, any changes to the definition should expand (and not contract) the pool of accredited investors. As an example, the Advisory Committee recommends including within the definition investors who meet a sophistication test, regardless of income or net worth.

Second, the Advisory Committee recommends that the SEC should, on a going forward basis, periodically adjust the dollar thresholds in the definition for inflation according to the consumer price index.^[5] As its final substantive recommendation, the Advisory Committee suggests that the SEC should focus on enhancing its enforcement efforts and increasing investor education, rather than attempting to protect investors by raising the accredited investor thresholds or excluding certain types of assets from the net worth calculation.

The Advisory Committee was established in 2011 to advise the SEC on its rules, regulations and policies with regard to its mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation, as they relate to (1) capital raising by privately held businesses and smaller public companies, (2) trading in the securities of privately held businesses and smaller public companies and (3) public reporting and corporate governance requirements of privately held businesses and smaller public companies.

While the SEC is not bound to follow any of the Advisory Committee’s recommendations, the SEC gives significant weight to the views and recommendations made by the Advisory Committee when considering new rulemaking initiatives. The Advisory Committee’s recommendations are a positive sign for companies in South Florida as they continue to grow their operations and break ground on new projects.

^[1] The Advisory Committee’s written recommendations are available on the SEC’s website.

^[2] Under current rules, an individual can qualify as an accredited investor if he or she either (a) had more than $200,000 of income (or more than $300,000 of joint income with a spouse) in each of the prior two years and reasonably expects to have the same income level in the current year, or (b) has a net worth (individually or with a spouse) of more than $1 million excluding the value of his or her primary residence.

^[3] A study published in July 2013 by the U.S. Government Accountability Office (GAO) includes an analysis of household net worth and shows that adjusting the $1 million net worth threshold for inflation (dating back to 1982 when the threshold was initially adopted) would increase it to $2.3 million and would decrease the number of households qualifying as an accredited investor by more than 50% (from 8.5 million households to 3.7 million households).  Click here to read the study.

^[4] The dollar amount raised in private placements is based on information reported by issuers who file Form D with the SEC in connection with Rule 506 offerings. The actual dollar amount raised in private placements is believed to be significantly higher than what issuers report in those filings primarily because (a) issuers do not always file Form D in connection with their Rule 506 offerings (since, under current rules, they do not lose the Rule 506 exemption if they do not file Form D), and (b) issuers that are engaged in offerings that continue after filing Form D are not required to update their Form D to report the amount of securities sold upon the final closing of their offering.

^[5] In 2007, the SEC published proposed amendments to Rule 501 of Regulation D to adjust all dollar thresholds in the definition of accredited investor on a going forward basis, starting on July 1, 2012, and every five years thereafter, to reflect changes in the Personal Consumption Expenditures Chain-Type Price Index as published by the Department of Commerce. See SEC Release No. 33-8828 (Aug. 3, 2007). These proposed amendments were never adopted.