Did the SEC Set the Bar Too Low for Private Market Investors?

The Securities and Exchange Commission announced Wednesday it has amended its rules to allow more individual investors to make bets in private markets — but not without dissent.

Commissioners Allison Herren Lee, who was sworn into office last year, and Caroline Crenshaw, sworn in this month, objected to the SEC’s expanded definition of a so-called accredited investor, or an individual or entity that can invest in unregistered securities.

“The accredited investor definition is the single most important investor protection in the private market,” they said in a joint statement Wednesday. “With its actions today, the Commission continues a steady expansion of the private market, affording issuers of unregistered securities access to more and more investors without due regard for the risks they face.”

The new policy fails to protect vulnerable investors — particularly seniors — from the heightened risks of locking up their capital in opaque private markets, according to their statement. Protecting investors is at the very core of the SEC’s mission, they said, arguing the regulator has done insufficient analysis on private markets to carry out that goal.

For private-capital fund managers, the rule change invites more money to flow into their coffers, providing a potentially larger pool of assets from which they may collect fees. While institutional investors such as pension funds have increasingly reached for yield in the ballooning private markets, the SEC has shielded ordinary investors from risking their assets beyond more visible public markets.

Meanwhile, the threshold for wealth under the accreditor investor definition was left in place under the SEC’s new rules, bolstering further expansion in private markets without regard for inflation since it was set about 38 years ago, according to Lee and Crenshaw. The minimum wealth requirements should be indexed for inflation, they said.

“The failure to update the thresholds thus far has resulted in an increase of 550 percent in qualifying households since 1983,” they said. “Capital raised in the private markets continues to grow at unprecedented rates.” 

[II Deep Dive: The Consequences of Shrinking Public Markets]

According to SEC Chairman Jay Clayton, wealth thresholds alone are an “unsatisfactory” way of measuring who gets to participate in private markets and who does not.

“It is not clear that, for example, persons with $1.5 million in net worth are any more financially sophisticated than persons meeting the current $1 million threshold or persons with $500,000 or $50,000 in net worth,” Clayton said in a statement Wednesday. 

“Individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to invest in our multifaceted and vast private markets,” the SEC said of the amended definition of what it means to be an accredited investor. The amendments “more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.”

That is, investors may qualify based on “defined measures of professional knowledge, experience or certifications,” the SEC said. For example, holders of the Series 7, Series 65, and Series 82 licenses who are “in good standing” would qualify. 

Meanwhile, Lee and Crenshaw worry that seniors tend to accumulate wealth gradually overtime in their retirement accounts “rather than necessarily as a result of financial sophistication.” They said that “unregistered offerings are consistently used in fraudulent schemes to target seniors.”

The SEC also expanded the list of organizations that can invest in private markets, including tribal governments, family offices with at least $5 million in assets under management, and “spousal equivalents” who may pool their finances in order to qualify as accredited investors.

The debate about whether the SEC may have gone too far in relaxing requirements to participate in riskier private markets quickly made its way social media. 

One skeptical Twitter user, @richtechexec, weighed in with hyperbole to make a point: “New SEC accredited investor requirements: 1. Know what money is 2. A pulse.”

Cameron Winklevoss, the co-founder of cryptocurrency exchange Gemini, used Twitter to express his support of the SEC’s expanded definition of accredited investor.

“Previous rules ensured only the rich get richer,” Winklevoss tweeted Wednesday. “Increasing access & opportunity is crucial 2 increasing equitability of The American Dream. This is a step in the right direction.”