July 19, 2010
Dodd-Frank: Accredited Investors
Posted by Gordon Smith

Back in March, when the Senate Banking Committee approved an early version of the financial reform bill that ultimately became Dodd-Frank, the angel investor community was in a tizzy. That bill would have increased the thresholds for "accredited investors" from the current levels ($1 million in net worth or annual 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 would have required the SEC to adjust the new amounts "not less frequently than once every 5 years, to reflect the percentage increase in the cost of living." 

The current numbers were adopted in 1982. Adjusting those numbers for inflation could have changed the investment for angel investors dramatically. Doug Cornelius figured those levels could increase to $459,000 for singles and $688,000 for married investors, with the net worth requirement rising to $2.29 million. The Angel Capital Association sprang into action, claiming that this change would result in a reduction of accredited investors by as much as 77%. 

In response to the ACA, the National Venture Capital Association, and others, the bill was amended. Dodd-Frank has raised the net worth threshold for "accredited investors" (by excluding the primary residence from calculation of net worth) but prevents further increases for at least the next four years: "during the 4-year period that begins on the date of enactment of this Act, any net worth standard shall be $1,000,000, excluding the value of the primary residence of such natural person." Also under Dodd-Frank, the SEC is charged with adjusting the numbers within four years after 2014. The ACA is pleased.

So did Congress do the right thing in holding the line on accredited investor standards? 

The argument against changing the thresholds is straightforward: "At a time when many accredited investors have lost more than 20 percent of their net worth in 2008 and innovative start-ups are having an increasingly difficult raising equity capital, decreasing the potential pool of angel investors is counter-productive to supporting the very companies that will create new high-paying jobs."

I don't claim to know the right levels for the thresholds, but if we think that disclosure regulations provide valuable protections to some investors, those levels should be established at least in part by reference to the need for investor protection, not merely the need for startup funding. How does the fact that "many accredited investors have lost more than 20 percent of their net worth in 2008" argue in favor of maintaining the status quo? Speaking with angel investors, I sense that many (most?) of them place almost no value on disclosure regulations. While I am more than happy to play the skeptic on the value of mandatory disclosure, perhaps we ought to find out which investors, if any, benefit from the disclosure system before we set these thresholds.

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