Yesterday the Investor Advisory Committee of the Securities and Exchange Commission (SEC) met to discuss, among other things, updating the definition of an accredited investor. To be an accredited investor today a person must have an annual income of $200,000 or more for each of the past two years or a net worth (excluding a primary residence) in excess of $1 million.
The issue is that this definition was created several decades ago and has never been adjusted for inflation. So, some people believe it should be updated. If this happens, it could have a profound affect on this industry. Pretty much every investment option outside of Lending Club and Prosper is limited to accredited investors only. Any change to this definition that reduces the available pool of investors could be very damaging to some of the platforms and funds in our industry.
I reached out to several industry leaders to get their take on this new development. I wanted to see if everyone agreed with me that this could become a big problem. Here is what Jilliene Helman, CEO of Realty Mogul, a real estate marketplace for accredited investors, had to say:
It would be a shame to see the definition of an accredited investor become even more onerous. The JOBS act was meant to open up the private markets for investors, and adjusting the income or net worth requirements for accredited investors upward would serve the opposite purpose.
It’s incredibly important that investors are protected – and a core focus of ours at Realty Mogul, but what we’ve found is that the majority of our investors are highly sophisticated. I’d hate to see those investors lose out on the opportunity to invest in private markets if income requirements are increased by the SEC.
David Klein is the CEO of CommonBond, a student loan platform connecting borrowers with accredited investors and he had a slightly different take:
The rule was set over 30 years ago and hasn’t been redefined to account for inflation. From a purely economic perspective, the rule is begging to be changed, to the extent regulators want to maintain the same intent. As it relates to the effect on our industry, I think the idea of ‘accredited investor’ has the potential to become less important over time, regardless of definition, if legislation continues to go down the path that the JOBS Act has started to pave.
I can see a world in which finance is further democratized, giving more control to the individual investor. The JOBS Act provided a relatively limited capacity for individuals who wanted to be equity investors; I can see that capacity expanding over time as well as including individuals who want to be debt investors or lenders. That would open up the industry even further.
Brendan Ross is the president of Direct Lending Investments and he runs a high yield small business loan fund open to accredited investors. He provides us with the bigger picture here:
The US has 117 million households of which 7.4% are accredited under the income and net worth tests. Virtually every innovation in capitalism starts with private placements sold to these investors. Innovation then trickles down to the masses as creative financial entrepreneurs figure out how to stick the assets into a mutual fund. P2P actually stands alone as a financial innovation that started with retail investors, but that changed in 2011 when institutional investors discovered P2P. Since then, not a single new platform has been available to unaccredited investors. If the SEC were to meddle with the accredited investor definition, they could break the delicate equation that governs financial innovation. No one wants that.
Ethan Senturia is CEO of DealStruck, a small business lending platform open to accredited investors. He doesn’t see much immediate impact if there is a rule change here:
As we’ve seen from the P2P market over the past couple of years, a restriction on accredited investors likely won’t have much of an initial impact on the industry, as institutions have become the largest providers of capital to P2P lending platforms. As the market evolves, however, a core premise of P2P is not only the democratization of access to capital, but the democratization of access to capital markets. Restricting the ability of individual investors to participate even further than under existing standards forces them to invest through some of the exact institutions that failed them during the crisis and that P2P was established to circumvent.
What has not been mentioned here is the reason behind the accredited investor rule. The rule has been put in place with the assumption that people with a high net worth are somehow able to make better financial decisions than the general public. This may be true in many instances but some of the most financially savvy people I have ever met have been non-accredited investors and I have certainly met some wealthy people who were pretty clueless when it came to money management.
Of course, doing some kind of means test for investors would be very difficult and expensive to implement. But banning everyone below these high thresholds also seems wrong to me. And increasing these thresholds will do virtually nothing to further protect investors. I certainly hope they leave the definition unchanged.
If you are interested in learning more the SEC Investor Advisory Committee meeting was covered in more depth by Think Advisor.
