Politicians Can Really Screw Things Up – Accredited Investors

When government officials and politicians try to define who should and could invest in the markets and which market they can invest in, things can sure get messed up. Just a few years back the US adopted a term to describe investors who could invest in non-retail markets. They called this class “Accredited Investors” and boy did they screw things up. But it is not only the US that sets up categories for investors. This category or class has been set up in Australia, Brazil, Canada, the European Union, Israel, New Zealand and Singapore Now let’s not get this mixed up with business or investment brokers or managers. These classes are for individual speculators or persons investing their own money.

Investopedia offers the best definition saying It takes money to make money, and accredited investors have more opportunities to do so than non-accredited investors. That’s because the Securities and Exchange Commission (SEC) allows companies and private funds to skip the need to register certain investments so long as the firms sell these assets to accredited investors. Accredited investors are able to invest money directly into the lucrative world of private equity, private placements, hedge funds, venture capital, and equity crowd funding. However, the requirements of who can and who cannot be an accredited investor – and thus take part in these opportunities – are determined by the Security and Exchange Commission.

Few words or phrases have the ability to affect the U.S. economy like the term “accredited investor.” Whether you know it or not, these two little words control $800 billion of private investment in the United Stated today. The standards for qualifying as an accredited investor have remained relatively unchanged since the 1980s but that may all change soon as the Securities and Exchange Commission (SEC) considers adopting serious changes to these standards, and the changes may spell trouble for investors and entrepreneurs. (Crowdfund)

 

There is a common misconception that a “process” exists for an individual to become an accredited investor. No government agency or independent body reviews an investors credentials and no certification exam or piece of paper exists that states a person has become an accredited investor. Instead, the companies that issue unregistered securities determine a potential investor’s status by conducting diligence prior to sale.

Now all this makes a lot of sense, it is when these government, regulators and politicians try to find a way to define a person who is an “Accredited Investor” that things get really screwed up. The 2010 Dodd-Frank Act defines an “Accredited Investor” as a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person.”

So let’s see who will be an “Accredited Investor” by the rules set by US politicians. The Dodd Frank law takes the ability away from the Securities and Exchange Commission and only allows them to enforce it.

Investor #1 is a well-known Romance author who earns well over $200,000 per year and has a net worth well in excess of $1,000,000 excluding her residence. She has never invested in the markets except is some stocks and bonds and her home.

Investor #2 is a fisherman who after 40 years just sold his boat and his business and has over $1,000,000 in the bank. Mr. Fisherman, never graduated high school but was able to put his kids through college and pay for his house.

Investor $3 just completed his PhD in economics, has an undergraduate degree in accounting and a Masters in finance. He teaches at a University. Mr. Teacher, just bought his first home, and has liquid assets of about 50,000.00

Under Dodd- Frank and in most other countries around the globe Investors #1 and #2 would be classified as “Accredited Investors’ while our Economics professor would not.

The SEC said recently that while these individuals qualify as “accredited investors” under the income and net worth tests, there is nothing in the definition that helps to identify whether these individuals have the financial sophistication and/or investment experience to be able to assess whether any particular investment is appropriate for them.

The SEC has started to push US lawmakers to change the law, but the SEC has little in its power to make that happen.

There is realization around the world that regulation and laws should protect investors they cannot make laws that cover who has what knowledge and abilities simply in financial terms.  In anticipation of the SEC’s review of the accredited investor, the SEC has been soliciting comments on how the definition of accredited investor should be modified.

US Congressman Garrett and Congressman McHenry correctly identified in their letter, there are several other factors beyond wealth and income which could be better predictors as to whether an individual is sophisticated enough to make reasonable investment decisions. These include (among others) an individual’s educational background or profession and/or whether they are working with a professional. By including such standards as stand-alone qualifications not only will it result in a substantial increase in the already $900 Billion private placement industry (meaning a greater amount of capital for start-ups and small businesses) but it would also increase the sophistication of the investor pool.

There has also been debate about whether the SEC should consider non-financial standards for accredited investors, such as education or professional background.

The Commission’s Investor Advisory Committee (“IAC”) has pointed out, the current “accredited investor” definition may be under-inclusive. Potential investors who most people would consider to be financially sophisticated, such as a Chartered Financial Analyst or a graduate professor of corporate finance, may not have the income or the accumulated net worth to be eligible to be “accredited investors,” but they may actually be better able to protect their own interests.

This is why the IAC has recommended changes to the accredited investor definition that take into account other ways of measuring financial sophistication. These recommendations include assessing an individual’s specialized work experience, investment experience, licensing, or other professional credentials.

While the commission cannot change the law they have the ability to interpret and enforce the law and make recommendation that the US congress to enact. In the meantime there is no enforcement and only the person or company offers the investments determines if the investor fits the title of “Accredited Investor”

Crowdfunding has become such a popular investment for new business ventures the public uproar has forced the SEC to reinterpret the laws. Just a few months ago the Securities and Exchange commission issued a new bulletin changing who can invest in crowdfunding. The SEC Bulletin states Crowdfunding generally refers to a financing method in which money is raised through soliciting relatively small individual investments or contributions from a large number of people.  Over the last few years, crowdfunding websites in the United States have proven a popular way by which to solicit investment capital.

Under recently adopted rules, the general public will have the opportunity to participate in the early capital raising activities of start-up and early-stage companies and businesses.  Starting May 16, 2016, companies can use crowdfunding to offer and sell securities to the investing public.

The next recommendation is to allow sophisticate individuals or investors with education credentials showing they have the knowledge and training to understand risk and make intelligent informed decision to be “Accredited Investors”

To this end, there are numerous colleges, universities and academies offering programs to help certified and train potential investors to obtain the level of knowledge and education to be acceptable as an “Accredited Investor”. Becoming an “Accredited Investor” does not mean that you are a successful and smart investor, it means that you understand the risks and know how to ask the right questions.

Recently the Investors Trading Academy began offering its certification course which has a minimum of 20 hours of class as well as exams to get their new certification. ITA.academy firmly believes an informed knowledgeable public is important and that laws should stop scam operators taking advantage of investors, but a person should be able to make their own informed decisions.