The SEC has issued a proposal to expand the definition of “accredited investor” as used for the Regulation D safe harbor for private offerings. This press release/fact sheet summarizes the changes. There are a number of technical updates to reflect developments in how business is now conducted, e.g., LLCs with sufficient assets would qualify in the same manner as corporations now do. However, the change that would likely have the most impact, at least in my practice, is the inclusion as accredited investors of natural persons with appropriate professional certification, such as holders of a Series 7 securities license, even if they don’t qualify under the existing standards for natural persons for income or net worth. I’m not aware of any significant opposition to this concept and assume it will be enacted by the SEC after public comment.
However, any time the topic of the accredited investor definition is raised serves as a trigger for me to raise the issue of investment limits in private offerings. Crowdfunding offerings under Regulation CF, enacted in recent years and still used far less than Regulation D, impose investment limits on investors that are based on a percentage of the investor’s income or net worth. Accordingly, the structure precludes a total financial wipeout of the individual investor as a result of a failed investment.
Nothing like this is a part of Regulation D as it exists now or as it’s proposed to be amended under the proposal, though the SEC does solicit comments on the possibility. Under the rules, as long as a natural person meets the income or net worth thresholds, there’s little to preclude an investment (and, potentially, a complete loss) of that person’s entire nest egg in a single private placement. The SEC cites a few comment letters responding to a previous release who were opposed to investment limits. Many of these comments say that such a limit would be “paternalistic.” I don’t view this as a serious argument. All securities regulation is paternalistic in the sense that it’s stepping in to protect investors and not leaving them alone to defend themselves against fraud. It’s a question of degree in this particular circumstance: do unsophisticated investors that nonetheless qualify as accredited investors require protection above and beyond current law.
The more serious objection to investment limits is that they may be hard to implement practically and could impede capital raising. I would not favor any policy that imposes on the issuer an obligation to police all their investors’ other investments to ensure they are not exceeding an overall limit. However, could we not simply include as part of an accredited investor questionnaire a confirmation that this investment does not exceed certain personal thresholds? Will such a light-touch approach work 100% of the time in precluding irresponsible investments? Of course not, but if it slows down a bunch of them and protects many investors from a wipeout, then it’s worthwhile.
