The SEC recently issued a long “concept release” on harmonization of securities offering exemptions. Whenever I hear about one of these, my first thought is that it’s somehow like a concept album from a ‘70s prog rock outfit (and therefore to be avoided), but in reality, the point of concept releases is to solicit input from the securities law community on a broad topic without immediately proposing changes. In this case, it’s about the complex web of exempt offering types that have evolved over the years and whether and how to harmonize them.
There’s plenty to chew on in the release, and I’ll likely address separate topics in later posts, but there’s one idea that I hope the Commission emphasizes going forward in its rulemaking: limits on individual investments. Some of the more recent exemptions have introduced the idea of limiting an individual’s investment in an offering, for example, a limit of 10% of a person’s annual income or net worth, as in crowdfunding offerings under Regulation CF and certain Regulation A offerings. I think the concept should be expanded and become part of the foundation of the law of securities offerings generally. The concept release generally speaks about investment limits more as an “add-on” to existing rules, such as the accredited investor definition’s use of income and net worth thresholds.
The SEC’s main goal in doing what it does is not to protect investors from any investment loss, as by their nature, securities go up and down in value, even when purchased by the most sophisticated investors. Rather, a key aim is to prevent investors from being financially wiped out by bad investments, particularly by fraudulent promoters. The SEC has sought to combat this, of course, by banning fraudulent practices, but also has done so indirectly by attempting to measure investment sophistication and putting up roadblocks against riskier investments by those deemed likely to lack the requisite knowledge.
But I would argue that if a wipe-out is what we’re trying to prevent, then investment limits are a better way to get there than trying to come up with numerical or other measures of sophistication. No matter what your investment acumen, if you are not permitted to part with more than 10% of your income or net worth, the damage is limited by definition. And the need for protection is not limited to those with meager resources. Imagine someone with minimal assets and investment knowledge who suddenly inherits $10 million. Is it a good idea for that heir to invest the full $10 million in a neighbor’s can’t-miss theme restaurant idea? Of course not, but since the heir is comfortably above the accredited investor net worth threshold, there’s nothing in current regulation to prevent it. But with an investment limit in place, the potential damage would be contained at $1 million.