Haves and have nots: The illusory promise of SEC investor protection
While the rule ostensibly aims to shield investors from financial risk, the evidence suggests a different narrative.
The recent unveiling of the SEC’s review of the Accredited Investor definition in December 2023 has disappointed many in the financial world. Despite widespread anticipation for a more inclusive approach, the rule remains exclusionary and lacking in genuine investor protection. It’s time for a paradigm shift—one that champions informed access and empowers all investors to participate in the wealth-building opportunities offered by private investments.
By proposing substantial increases in income and net worth requirements in defining who is an Accredited Investor, the SEC effectively prevents 16.8 million households from accessing private investment opportunities who qualify today. The current review’s narrow focus on adjusting thresholds overlooks the broader goal of fostering a more inclusive investment landscape.
At the heart of the matter lies a fundamental question: What exactly are investors protected from? While the rule ostensibly aims to shield investors from financial risk, the evidence suggests a different narrative. Are private funds indeed riskier than their public counterparts? Or are we inadvertently limiting access to potentially lucrative investment opportunities under the guise of protection? A sample of public versus private returns appears below:
| S&P 500 | Russell 2000 | Private Equity | ||
| Return | 3 Yr | 10.00% | 2.22% | 13.01% |
| 5 Yr | 15.69% | 9.97% | 15.86% | |
| 10 Yr | 12.03% | 7.16% | 14.24% | |
| 20 Yr | 9.69% | 8.11% | 13.16% | |
| Bloomberg US Corporate High Yield | Morningstar LSTA US LL Index | Private Debt | ||
| Return | 3 Yr | 1.98% | 5.76% | 11.86% |
| 5 Yr | 5.37% | 5.80% | 9.80% | |
| 10 Yr | 4.60% | 4.42% | 8.41% | |
| 20 Yr | 6.59% | 4.84% | 9.60% | |
| MSCI World Infrastructure | MSCI USA Infrastructure | Infrastructure | ||
| Return | 3 Yr | 1.55% | 2.03% | 14.68% |
| 5 Yr | 4.98% | 4.79% | 11.81% | |
| 10 Yr | 3.72% | 5.01% | 10.88% | |
| 20 Yr | 5.50% | 6.13% | n/a | |
| FTSE NareitAll Equity REITs | S&P United States REIT | Real Estate | ||
| Return | 3 Yr | 5.70% | 7.17% | 9.60% |
| 5 Yr | 7.59% | 7.22% | 7.85% | |
| 10 Yr | 7.95% | 7.50% | 9.35% | |
| 20 Yr | 8.28% | 7.94% | 8.28% |
Are we protecting investors from having superior returns?
Should we consider perpetuating the existing rule if the data doesn’t support the supposition?
Consider the story of two individuals: a 18-year-old accident survivor and a tenured professor of finance. The 18-year-old, having received a settlement of $3,000,000 after a traumatic accident, qualifies as an Accredited Investor despite lacking investment experience. Conversely, with a deep understanding of the markets and an average income of $195,000, the professor would not meet the Accredited Investor criteria. This stark example underscores the flaws in the current definition, highlighting how it spectacularly fails to account for actual financial sophistication.
The reflexive argument often invoked when visiting legislators or regulators is that these funds provide limited liquidity, and investors must be protected. Putting aside the arguments you typically hear on this topic, I posit the following: There is an abundance of existing regulations at the state and federal levels that already exist to preclude a recommendation that is not “suitable” or in the “best interests” of investors. If clients do not have sufficient liquidity, they should not invest in an illiquid offering, even if they earned $1,000,000 a year and had a $10,000,000 net worth. Wealth or high income doesn’t make every client suitable, as it should not make someone with less wealth and income unsophisticated and unsuitable. The liquidity test is a matter of both suitability and best interests. The definition doesn’t address the need to maintain an appropriate degree of liquidity, but other rules do and do it well. Conflating the issue is unhelpful and obfuscates the need to reexamine and improve this definition.
Enter the solution: an SEC-administered online courses, by asset class, for all prospective investors in private funds. This educational initiative, which already exists in the private sector, could be modeled after programs today administered by the SEC and FINRA for licensed professionals. Upon completion of the course, they receive a certificate that investment managers and Financial Advisors can use to qualify investors as “educated” (if not sophisticated) on the particulars of investing in the particular asset class/style relevant to the investment. It would address the fundamental concern and offer an investor a superior understanding of the risks and opportunities of the investment. It will benefit the public far more than the 60 seconds used to rip through 100 pages of disclosures that benefit the issuer more than the investor. The courses can be updated over time and require periodic retesting. Let’s create a new effective paradigm of disclosure that offers the proper protection the SEC is seeking and meets the public needs.
Finally, societal issues perpetuate and exaggerate the wealth gap in the United States. One of the cures was the democratization and access of the capital markets by reducing regulatory hurdles for 40-act investment funds (mutual funds and ETFs). The National Securities Markets Improvement Act is a prime example. It accomplished more for the middle class than anything I recall coming from Washington in my lifetime. It was dispositive in growing the wealth of the middle class by easing access to investment opportunities restricted as recently as the 1990s. Only 11 million households held Mutual Funds in 1983; today, almost 68 million enjoy the benefits (including ETFs). The SEC staff has a similar opportunity to make a massively positive impact on investors by amending the Accredited Investor definition. They should expand the universe of opportunity rather than restrict access to private funds. Do so while creating an improved disclosure format through education. Merely look at the data. Cutting off 16.8 million households from investing in private funds may have the unintended consequence of perpetuating “Haves and Have Nots”, not investor protection.
Mark Goldberg has served as chair and director of several financial services associations, CEO of brokerage firms, and currently as an independent director of several company boards. He has advocated on behalf of both investors and those who serve them for over 38 years, providing expert testimony at congressional hearings, and the Department of Labor.
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