The Securities and Exchange Commission’s (“SEC”) Advisory Committee on Small and Emerging Companies (the “Committee”) met on Wednesday, May 18, 2016, to discuss two main topics (1) the definition of “accredited investor” and (2) Regulation D. The discussion on the definition of accredited investor was necessitated by the SEC’s recent publication of its report analyzing such definition. As background, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) directed the SEC to review the definition of accredited investor every four years in order to determine whether or not the definition should be modified. The SEC published its first report under such Dodd-Frank requirement on December 18, 2015, entitled “Report on the Review of the Definition of ‘Accredited Investor’” (the “2015 Report”), which served as the basis for the discussion by the Committee.
Discussion of “Accredited Investor”
The morning session of the meeting focused on the term “accredited investor”, which was adopted by Regulation D in 1982 and amended under Dodd-Frank. An accredited investor is currently defined as a person who makes at least $200,000 in annual income or possesses $1M or more in net worth. It is presumed that individuals meeting the monetary requirements are sophisticated individuals and therefore possess the requisite knowledge to make informed decisions on whether or not to invest in a particular private or public investment. Additionally, it is presumed that those individuals who fail to meet the monetary thresholds need to be protected by the government from potentially making an investment of which such individual cannot bear the risk if the investment goes awry or is fraudulent.
At the meeting, the Division of Corporation Finance made a presentation on its 2015 Report, highlighting the recommendations it made for modification to the definition of an accredited investor. The overall agreement of the Committee members was that the primary goal behind any recommended changes to the definition of an accredited investor should be “to do no harm.” Some Committee members stressed that any recommendations should be analyzed in depth to determine what the outcome would be so as to not squelch private investment, especially in light of the increasing amount of money raised over the last few years through private investment.
The Committee discussed several suggestions and alternatives for potential revisions to the definition of an accredited investor, including the following:
- There was much discussion over whether the current monetary limits set in 1982 are even applicable today and whether the limits were arbitrarily set.
- Mark Walsh of the Small Business Administration, made a point that wealth and sophistication are not necessarily correlated and that today any person with access to the internet can find out much more information than was readily available in 1982.
- Catherine Mott, who runs a venture fund and angel investment group, stressed that market and economic considerations need to be weighed if a recommendation is made to adjust the monetary thresholds because there is a discrepancy in wealth and income among the same type of professionals in places like New York and Los Angeles versus elsewhere, such as Middle America.
- The Commissioner Michael S. Piwowar and other members also commented that there is a lack of data in the private investment front to determine if a change in the definition of accredited investor would have better outcomes for private investment. Michael Pieciak agreed with the Commissioner, in that his company examines offerings in all of the states, but much of the data is incomplete or not absolute.
The general consensus of the Committee was that there may be a need to expand the term “accredited investor” by adopting non-monetary measures in order to identify and encompass more individuals that are in fact sophisticated investors. A few of the non-monetary measures discussed where (a) to look at whether the potential investor is Series 7, Series 65 or Series 82 licensed, (b) to evaluate the amount of prior investment experience of the potential investor, or (c) to create an examination that can be taken in order to become an accredited investor. Additionally, several Committee members agreed that raising the monetary threshold may discriminate against minorities such as women and also individuals residing in places where annual income is traditionally lower.
The Committee made no decision on recommendations at the meeting on the topics of accredited investor status; however, the Committee agreed to draft recommendations on the accredited investor definition and circulate such for comment among the members in the next few weeks. The Committee plans to meet again on July 19. For now, however, no proposals to revise the definition of an accredited investor have come out of this meeting.
Discussion on Regulation D
The discussion during the afternoon session of the Committee meeting centered on the requirements that companies must meet when offering securities under 506(b) and 506(c) of Regulation D. Under 506(b), a company must have a reasonable basis for believing that a potential investor is accredited; however, for general solicitations under 506(c), the company must show that it took active, reasonable steps in order to establish a reasonable belief that that investor is accredited. There was a great deal of back and forth discussion regarding reliance by companies on answers to an investor’s questionnaire not meeting the burden of reasonable steps under 506(c); whereas such practice is sufficient under 506(b). It was also commented that a large segment of angel investors will not even think about investing under 506(c) due to the amount of work required in order to prove accredited investor status.
The Discussion on Regulation D was wrapped up with a presentation by a representative of the Division of Enforcement of the SEC on fraud the SEC has seen and pursued under Regulation D, and specifically 506(b) and (c). The summary of her presentation was that there have been eight cases pursued to date by the Enforcement Division, of which 3 were settled and 5 are ongoing. However, it was noted that activity under 506(c) has been slow and therefore data is hard to come by regarding fraud thereunder.
As with the discussion on the accredited investor definition, the Committee discussed the requirements of 506(b) and 506(c) under Regulation D, but made no decisions at the meeting.