The SEC’s plan to reconsider who is eligible to invest in startups’ privately-held share offerings is stirring questions about equity and diversity.
The agency’s most recent regulatory agenda includes a planned proposal to redefine “accredited investor” status, potentially restricting the pool of investors who can participate in certain types of private offerings in an effort to boost investor protection.
That policy direction could limit opportunities for investors from underrepresented communities and put the agency at odds with the Biden administration’s broader focus on diversity and equity, some advocates say.
“The inclusion of more people also pushes economic development, ingenuity, returns for a group of people who’ve been historically financially locked out of the ability to buy homes, locked out to levels of loans and access to capital,” said ShellyBell, founder and CEO of nonprofit crowdfunding organization Black Girl Ventures, who spoke at an SEC meeting earlier this month.
The Securities and Exchange Commission has considered the issue in the past, but only to make modest tweaks. The agency is expected to pick it up again in April with a request for public comment on changing the definition of accredited investors who can participate in privately held, “unregistered” share offerings of at least $10 million, according to the agency’s fall 2021 regulatory agenda.
The SEC’s Small Business Capital Formation Advisory Committee recommended at the end of a Feb. 10 meeting that the commission expand the definition in order to address diversity, equity and inclusion in capital markets and avoid exacerbating the wealth gap.
To qualify as accredited investor, a person currently must have at least $200,000 in personal income, or $300,000 for combined incomes, over the past two years, with the expectation of the same or higher income in the current year.
People with a net worth of more than $1 million jointly or with their spouse, excluding the value of their home, also qualify.
About 13% of U.S. households qualified as accredited investors in 2016, according to the SEC.
In 2020, the agency added some financial industry qualifications, such as serving as brokers or executives or directors of companies issuing unregistered securities.
The issue has resurfaced as private offerings continue to outpace SEC-registered public offerings. In 2019, private offering investment totaled $2.7 trillion, dwarfing the $1.2 trillion invested in registered offerings, according to SEC data released last year.
The SEC hasn’t clearly indicated which direction it would head in redefining accredited investors or whether it would raise the dollar thresholds for eligibility.
But SEC Chairman Gary Gensler has emphasized regulatory changes that generally aim to enhance investor protection and disclosure.
“Looking at the accredited investor definition is sort of one more lever that the SEC is looking at” for a safer marketplace, said Bradley Chernin, a partner at Covington and Burling LLP in San Francisco who specializes in venture capital and strategic investments.
Increasing the minimum asset requirements “really would exclude a large number of people, but probably have a smaller impact on the actual amount of money available” to startups, Chernin said.
That’s because the bulk of private offering investments comes from private equity and venture capital firms and other financial firms that qualify.
Still, such an asset-requirement increase raises questions about equity and inclusion for communities that historically have faced barriers to participating in capital markets, Chernin said.
A startup founder who wants to raise capital from underrepresented communities might feel “more constrained” if the SEC’s new definition limits such investors’ access, he said.
Investors of color are eager for the SEC to expand their opportunities to invest in early-stage companies.
“Financial sophistication needs to be questioned if the current rule that describes that level of financial sophistication makes sense only for a small pool of people,” Bell said.
She was one of the witnesses at the Feb. 10 advisory committee meeting who advocated for expanding the accredited investor definition.
Bell said she founded Black Girl Ventures after learning that Black women were starting companies at six times the national average, but receiving less than 1% of venture capital.
The SEC’s current rules prevent her from investing in the companies she identified and helped grow, Bell said.
The SEC advisory committee also recommended adding investment experience, membership in an organized angel group, particular types of professional degrees, and community leadership as credentials that would qualify an individual as an accredited investor.
In addition, the committee reiterated its 2019 recommendations that the asset or income thresholds not be raised, and that the SEC consider periodically indexing the thresholds to inflation.
But major consumer protection and fraud concerns could arise if more people are allowed to invest in companies that aren’t subject to the SEC’s rigorous disclosure requirements for publicly traded companies.
The SEC’s Democratic majority is more likely to raise the financial threshold requirements to be considered accredited investors than to lower or expand the definition, said Todd Phillips, director of financial regulatory and corporate governance at the Center for American Progress.
The purpose of the definition “is not to say you don’t need information,” he said. “It’s to say ‘we trust you to be savvy enough that you can negotiate disclosures yourself without having the SEC’s protection behind you.’”
Instead, expanding disclosure requirements to more companies would be a better way to broaden the pool of investors to include those who’ve traditionally been excluded from securities markets, Phillips said.
Otherwise, the SEC risks simply expanding the pool of people who can be sold risky investments without the appropriate disclosures, he said.