While there is much to ponder in Senate Banking Committee Chairman Christopher Dodd’s Finance Bill, the fact that Dodd’s drafting team have shoe-horned in a provision to raise the bar as to what constitutes an “accredited investor” (someone rich enough to decide for themselves where to invest their money) is causing a riot in angel investor circles in the US. The Bill wants to raise the stakes for accredited investor from $1 million in assets to $2.3 million in assets, or income of $450,000 per year versus $250,000 as the rule stands at present.
The debate is important for at least two reasons. As noted in my previous post on this topic, it will cut down the number of potential angel investors from roughly 9% of the US population to under 1%, which will stifle new business creation at the very time that the US government is desperate for new jobs in the economy. However, there is a second and perhaps just as fundamental and important dimension to the debate, since it throws into sharp relief the question of when regulation crosses the line between benign and malign.
The unlooked-for appearance of this raising of the bar on the definition of accredited investors came as a real surprise to many, but it is a project that the SEC has been pondering seriously for at least the last four years. In January 2007 the US market commentator John Mauldin drew attention to the new rule that the SEC had just proposed that would raise the minimum net worth requirement needed to invest in private funds from $1 million to $2.5 million. The old rule had been set in 1982 at a time when only 1.87% of US citizens would have qualified, according to the SEC. Today, in 2010, over 9% of US households meet the rule. Under the proposed amendments being considered by the SEC in 2007, the $2.5 million minimum would have to consist of investment assets (liquid or near-liquid assets) which excluded the family home, for example. This was clearly a pretty severe raising of the bar that the SEC was contemplating and it ran into a storm of opposition from hedge fund providers and others. In the end the SEC quietly put the project back on the shelf. Now someone on the Dodd drafting team has seen the opportunity to revive the project, albeit in a slightly milder form.
Why? There is a long history in the US of Congress wanting the regulator to protect those deemed to be unsophisticated investors from investing in anything other than mutual funds, on the grounds that they wouldn’t or mightn’t understand the risks involved. Somehow or other the notion of sophistication and the notion of wealth became intermingled, on no very good philosophical grounds, and wealth became a proxy for sophistication.
At the time, Mauldin pointed out that this was pretty muddled thinking and that there was something manifestly unfair about depriving quite a large number of people (8% of the US population) of the right to invest in private funds, by fiat, as it were—even if it was being done “for their own good.” Mauldin, along with just about everyone with a grain of sense, is quite ready to agree that hedge funds require a degree of sophistication from an investor and are not for everyone, but you do not have to be a dollar millionaire to understand risk, he points out. Moreover, in its 2007 musings, the SEC specifically exempted investments in private equity funds in general and angel funding in particular. This time around that exemption has vanished. Mauldin wants the US to move to the UK position where an investor has to go through an independent financial advisor (IFA) to access riskier types of investment, and where the IFA is responsible for making a decision on the suitability of the investment for that particular investor without regard to any arbitrary “accredited investor” barrier.
However, the US is moving inexorably towards more, rather than less regulation, and until the regulatory tide turns again, it is going to be a hard struggle for those who value their liberty to prevent “regulatory creep” of this sort…
Further reading on investment regulation
- Optimizing the Capital Structure: Finding the Right Balance between Debt and Equity, by Meziane Lasfer
- Understanding Equity Capital in Small and Medium-Sized Enterprises, by Siri Terjesen
- Assessing Opportunities for Growth in Small and Medium Enterprises, by Frank Hoy
- Oops, we just killed angel financing…, by Anthony Harrington [blog post]
Tags: angel financing , regulation , Senator Chris Dodd , start-ups , transparency , US