Scrap the Accredited Investor Rule

July 29, 2011

The Securities and Exchange Commission (SEC) should make it easier for non-accredited investors to invest in private companies by eliminating the requirement that a person be an "accredited investor" for the company to receive an exemption from registration, says Scott Shane, the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

  • The Securities Act of 1933 compels companies selling financial securities to register that offering with the SEC unless the company can obtain an exemption.
  • An exemption exists for the sale of securities to "accredited investors" under rules 505 and 506 of regulation D.
  • An accredited investor, the SEC explains, is "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" or "a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year."

Reasons to scrap the accredited investor rule include:

  • Accredited investors are not necessarily more financially sophisticated than non-accredited ones.
  • Accredited investor requirements do little to protect investors from fraud.
  • The accredited investor rule blocks poorer people from coinvesting with and learning from wealthier investors.
  • The accredited investor rule makes it harder for entrepreneurs to raise money for their businesses.

Rather than restricting investment to accredited investors, the SEC should simply limit the amount of money an outside investor can put into a single private company to no more than 1 percent of the investor's net worth.  By basing the rule on the percentage of net worth invested per company, the SEC could facilitate investment by non-accredited investors, while simultaneously encouraging the diversification necessary to protect investors against the risk of investment failure.  By setting the threshold at 1 percent of net worth, the SEC could ensure that any loss incurred would not be devastating to any investors, says Shane.

Source: Scott Shane, "Scrap the Accredited Investor Rule," The American, July 20, 2011.

For text:

http://www.american.com/archive/2011/july/scrap-the-accredited-investor-rule

 

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