July 12, 2013
General Solicitation Relaxes: "Accredited Investor" Carries the Weight
Posted by Erik Gerding

Unless you've been asleep, you've heard that the SEC Commissioners voted 4-1 on Wednesday to relax the general solicitation ban for Rule 506 and Rule 144A offerings.  It was not a terribly surprising result given the language in the JOBS Act.  Nor is the reaction from startup community boosters and hedge funds.

Now comes an analysis of unintended consequences.  One: mutual funds are not happy with the relative advantage that hedge funds may enjoy in advertising.

Here is my own take.  Much hay has been made that issuers relying on 506 still need to take steps to ensure that their investors are accredited investors.  Ultimately, the securities laws are making the accredited investor definition do more and more work in protecting investors.

But how good is the definition at the task at hand?  Net worth or income are not great proxies for measuring the financial sophistication of individuals.  Perhaps they are better at measuring an individual's capacity to bear risk but a net worth of $1 million or annual income of $200K is not that much of a cushion against financial loss on sophisticated investments.

It may make some sense to have accredited investor definition play a role in multiple securities rules to ease compliance.  But it also creates what engineers might call a single point of failure.

Consider how much of the architecture of financial regulations came to rest on rating agencies.  That single point of engineering failure indeed failed.  And we have yet to come up with other pillars on which to reconstruct the regulation of financial institution risk-taking.

It is high time to think about a more robust measure of investor sophistication and capacity for bearing risk than the current accredited investor standard. 

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