Memo to the Government: It Doesn’t Have to Be This Way

The leading presidential candidates want to make America “great” and “whole” again.

Whatever that means.

I’m more interested in making America fair again.

I’ll tell you exactly what I mean.

It’s an equal opportunity investment issue. Not only are the governing rules unfair, but they’re completely inadequate.

It’s something that would be easy to fix.

And it would make Americans better off financially for the long haul.

I deal with this issue every day…

And every day I tell myself it doesn’t have to be this way. If only…

If only what?

If Only the Government Would Act

The government decides who gets to invest in startups. Let’s not argue over that. They’re the cards we’ve been dealt.

The good news: The government has issued new “ground-floor investing for everybody” rules. The rules let everybody – regardless of income or wealth – invest in startups raising money under Title III and Regulation A+.

There are restrictions, but it’s a step in the right direction. See our previous articles here and here for more details.

The situation is far from fair, however. Some of the best startup opportunities out there are available to only a small minority of investors.

They’re called “accredited investors.”

The definition is fairly simple. Accredited investors have to make at least $200,000 a year, or have a net worth of more than $1 million (excluding primary homes). For a married couple, the requirement goes up to $300,000.

The “accredited investor” definition was written in 1982. Since then it has undergone a single change, made in 2011. The SEC decided to exclude primary homes from its net worth calculation.

I think the current definition stinks. But it’s not just me. Everybody who has been paying attention to this issue seems to agree.

The Investor Advisory Committee thinks so. It was established by the Dodd-Frank financial reform law specifically to look into these rules.

In October 2014, it said the rules don’t do their job. That many individuals who aren’t allowed to invest (because they don’t make enough money) should be allowed. And many who are allowed shouldn’t be. They’re wealthy but, for example, may not have a good understanding of their risk exposure.

That was 17 months ago.

Last month, the head of the SEC, Mary Jo White, said, “I don’t think, at least alone, that the net worth and income criteria by themselves are a very good, or at least not optimal, proxy for who doesn’t need the protections.”

That’s an understatement. This is America; there shouldn’t be a class of investments that only rich people can invest in. Yet that’s the way it is.

Sounds like a consensus has been built to backstop a new and better definition, right?

Ah, but this is the government. So instead of writing a new definition, the SEC invited comments to the committee’s report.

It then wrote a new report updating the old one; a report on a report.

It came out last December. And now, I kid you not, the SEC is once again collecting comments, this time on its latest report.

Plenty of Options and No Discernable Direction

The report put forward a number of recommendations…

  • Leave the current thresholds alone while limiting investments based on a percentage of income or net worth.
  • Adjust the thresholds for inflation: A $500,000 income minimum and $2.5 million net worth minimum is suggested.
  • Adjust for inflation but only in future years going forward.
  • Permit all entities with investments in excess of $5 million to qualify as accredited investors.
  • Qualify based on measures of sophistication, such as passing an investment exam or holding professional credentials (such as the Series 7 license).

In the meantime, legislators have jumped into the fray. On February 1, the House passed H.R. 2187, which amended the accredited investor definition.

It would include currently licensed or registered brokers or investment advisors. It would also add people demonstrating relevant education or job experience “as verified by the Financial Industry Regulatory Authority or an equivalent self-regulatory organization.”

Sound familiar? Congress merely followed some of the suggestions in the SEC’s report.

The bill is in the Senate now. This is an election year. So I’m not holding my breath. I don’t expect the Senate to act with any sense of urgency.

Which brings us back to the ever-equivocating SEC.

What’s Next?

The SEC has put forward plenty of options. SEC chief Mary Jo White isn’t saying which way the SEC is leaning, only that the definition “needs changing.”

It’s what the SEC’s first report said 17 months ago.

If she were head of the China Securities Regulatory Commission (CSRC), she would do her bosses proud.

But c’mon. This isn’t China. Why all the secrecy? Why all the stalling?

I’m not exactly shocked by the SEC’s snail-like progress. It’s the government, after all. But I am frustrated.

Congress has shown that expanding the definition is not that complicated.

But does the SEC even want to? Almost a year and a half after it published its first report on this issue, we still have no idea.

This is a pretty impressive demonstration of stonewalling, even by government standards.

And if the SEC does raise income and net worth minimum levels to $500,000 and $2.5 million (one of the options in the SEC’s latest report)? It would immediately disqualify more than 60% of accredited investors, according to a study done by the Angel Capital Association.

Is this what the SEC really wants?

It would certainly NOT be keeping with the general trend of expanding and opening up startup investing to more and more people with fewer and fewer restrictions.

It would be a big step backward on the road to investment fairness.

The SEC has all the tools, information and public feedback it needs to adopt a new definition that more meaningfully reflects investor sophistication.

Please, no more reports!

It’s not that hard. Just level the playing field already.

Invest early and well,

Andrew Gordon
Founder, Early Investing