In a letter to House oversight committee chairs, SEC Chair Mary Jo White said that the Commission staff has begun a comprehensive review of the accredited investor definition. The review will encompass, among other things, the question of whether net worth and annual income should be used as tests to determine whether a natural person is an accredited investor. As part of that review, SEC staff also plans to consider and independently evaluate alternative criteria for the accredited investor definition suggested by the public and other interested parties. Once the review is completed, said the chair, the SEC will consider whether to change the definition through the notice and comment rulemaking process. As part of that process, pledged the chair, the SEC would engage in a thorough economic analysis of the impacts of various approaches to defining accredited investor.
Chair White’s letter was in response to an earlier letter from Rep. Scott Garrett (R-N.J.), chair of the House Capital Markets Subcommittee and Rep. Patrick McHenry (R-N.C.), chair of the Oversight and Investigations Subcommittee of the House Financial Services Committee.
Section 413 of the Dodd-Frank Act requires the SEC to undertake a review of the accredited investor definition in its entirety as it relates to natural persons four years after enactment. Chair White expects that the review the staff is undertaking and the feedback received through that process will inform the Commission's consideration of whether or not to change the definition.
The SEC chair responded to a number of specific questions asked by Chairmen Garrett and McHenry. The House oversight chairs contended that permitting sophisticated investors, such as certified public accountants (CPAs) and chartered financial analysts (CFAs) to participate in private investment opportunities would improve information dissemination and analysis surrounding such opportunities. By excluding these highly trained financial professionals from investing in certain offerings, unless they meet wealth or income tests, the chairs wondered if the SEC is placing accredited investors at risk. They also wondered whether the review of investments by trained professionals with vested interests would help reveal problems of an issuer.
Chair White responded that professional certifications, such as a CPA or a CFA, are among the possible supplemental or alternative criteria for qualifying as an accredited investor that SEC staff will consider as part of its review. Such a certification, she acknowledged, may position an individual to be able to analyze more comprehensively a company's financial condition and results of operations. The question of whether those with certain licenses, including CPAs, CFAs, and securities licenses or degrees, should provide an independent basis to qualify as an accredited investor will be part of the staff’s review.
Analysis of the income levels of various licensed professions may help to evaluate the marginal impacts, including the impact on capital formation, of allowing for this type of qualification when compared to the current population of accredited investors. For example, certain licensed individuals may already qualify as accredited investors because of their income or net worth. White also noted that the inclusion of more financially sophisticated investors in the definition of accredited investor should increase the extent of the expert review of issuances.
Responding to a question on liquidity, the SEC chair said that expanding the pool of accredited investors potentially could increase the liquidity available for private market investments, although any change in the pool of accredited investors must consider the qualifications of the investors added to or subtracted from the pool. The Commission staff is considering the degree to which the size and composition of the pool of accredited investors could affect liquidity and issuers' ability to raise capital through private offerings. This consideration will include an analysis of the potential overlaps in the various pools of investors that could exist under various definitions.
For example, if there is significant overlap with the set of individuals who would qualify under an income or net worth test, then including criteria other than income and net worth to determine whether an individual meets the accredited investor standard may not materially change the pool of accredited investors. If, however, including criteria other than income and net worth seems likely to increase the pool, then further analysis could include evaluating possible investment levels by those additional investors, and evaluating potential impacts on capital formation.
Responding to a congressional query on whether reliance on a qualified broker or registered investment adviser should enable ordinary investors to participate in Regulation D Rule 506 offerings, Chair White assured them that question is one of many factors that the staff will consider.
White added that obtaining the advice of a professional adviser may enhance an investor's ability to make an informed investment decision, and therefore strengthen investor protection in Rule 506 offerings. White cautioned, however, that an investor's use of such an adviser may not necessarily measure the investor's understanding of the risks of the investment. As part of its review, the staff may determine that it is feasible to analyze the extent to which investors file claims against professional advisers arising from investments in unregistered offerings. Such an analysis may assist in evaluating the level of protection afforded to investors when relying on professional advisers.
Noting that the Regulation D 506 market raises equity capital in excess of one trillion dollars annually, a level exceeding that of the combined public debt and equity markets, the representatives asked the macro question of whether diminishing the pool of eligible investors could potentially harm U.S. GDP.
Chair White replied that the staff review of the definition of accredited investor will consider the potential economic consequences of using alternative criteria to qualify as an accredited investor. Indeed, understanding these potential economic consequences will be an integral component of the review, and an essential part of the staff’s work during this process.