You are too poor to invest…

I have a hypothetical question for you – if you tried to invest in an early stage start-up or perhaps fund a peer-to-peer loan and you were not allowed, simply because your bank account was not big enough, would it upset you?  I hope so.

Today, most Americans are specifically excluded from the freedom to choose where to invest their money; based on the offensive and dubious claim that income and bank account size determine one’s ability to make certain investment decisions.

Currently, the SEC is accepting comments on a proposal that COULD change the rules and would finally allow main street investors to participate in the same risky but lucrative investments that were previously only open to the rich.

Specifically, Section V of the Proposed Rule states that,

“in light of the considerations that commenters raised, the Commission staff has begun a review of the definition of accredited investor as it relates to natural persons, including the need for any changes to this definition following the effectiveness of Rule 506(c).

This review, which we anticipate will be completed in a timely manner, will encompass, among other things, both the question of whether net worth and annual income should be used as the tests for determining whether a natural person is an accredited investor and the question of what the thresholds should be for those and other potential tests.”

I wrote about this last year, when the initial comment period opened and I submitted the comments below:

Dear SEC,

I agree with the comment submitted by Kiran Lingam at SeedInvest on July 8, 2014 available at http://www.sec.gov/comments/s7-06-13/s70613-546.pdf that raising the accredited investor thresholds would be disastrous for startups, job creation and the U.S. economy.  I believe the SEC should refrain from increasing these thresholds and should also adopt knowledge/experience based standards for an individual to become an accredited investor.

Under the current rules and definitions, I am not considered an accredited investor.  I am a young working professional with a degree in economics and finance and yet the “accredited investor” rules have precluded me from having the opportunity to invest in numerous opportunities.  While I can appreciate and understand the concern to protect investors, I absolutely cannot reconcile the use of what equates to financial discrimination as an appropriate tool to achieve such results.  The thresholds for income and wealth, at best, seem arbitrary and biased towards those who already have wealth.

In an environment where many Americans already feel like the deck is stacked against them, where wealth begets special privileges, where markets and the government rules that control it seem less and less egalitarian;  this rule only exacerbates the sentiment.  The right to invest in private companies should be just that, not a privilege available only to those with means.

Again, I kindly urge you to consider in earnest the comment submitted by Kiran Lingam at SeedInvest on July 8, 2014 and with particular attention to those related to adopting knowledge/experience based standards for an individual to become an accredited investor.  Protecting investors is an important function of the SEC, excluding many Americans from investing in private companies is not.

Just last month, during a May 13 House Hearing on P2P lending, the committee heard comments from representatives of the industry.  Overall, I agreed with most of their comments, except this part.  In fact, I took particular issue with this specific statement:

Peter Renton, from Lend Academy, said that, “Today, retail investors get a good deal.  Retails investors can invest in Lending Club, on Prosper, on Funding Circle. They can invest in loans, and … the playing field is level.”

You can watch the entire hearing here.

This statement is not accurate and leaves out one very important fact – not all retail investors have access to the same deals.  Because of SEC rules on who is considered an “accredited investor”, many Americans cannot access the same investment opportunities as their “accredited” counterparts.  Let me explain.

The P2P lending market really consists of two submarkets.

  1. The first market is that where loans are originated; this is where it all begins.  Borrowers come to the P2P lending platform of choice (Lending Club, Prosper, Funding Circle) and ask for money.  Investors choose which loans they want to fund and originate the loans.  So at the end of the day, the borrower gets their loan funded and the investor has a place to park their money.
  2. The second, and less discussed, is the secondary market.  The secondary market is where existing loans can be bought and sold among investors.  This market is open to all investors.  This, in my opinion, is a critical component of the overall P2P lending market because it provides liquidity.    Anyone that makes investments knows how important liquidity is.

Because of the SEC rules, “accredited” investors have access to both the origination and secondary markets for loans.  HOWEVER, everyone else can only access the secondary market.  In other words, most Americans are only serving as a liquidity tool for “accredited” investors.  I gave more details about this back in 2013 when I wrote about my experience using Lending Club.  To paraphrase my ending comments,

“I feel that their secondary market is a sham that serves more as an exit for the originating investors than it does an actual market for everyone else.

Buyer beware”

Utopian Shift LLC made excellent points in their letter to the SEC.  I recommend you read it.  Overall, they beautifully illustrated the absurdity of telling folks that they can engage in the MUCH riskier activities, such as trading on margin, pattern day trading, commodity and securities futures trading, and FOREX trading, but cannot participate in private placements that fund investments in start-up companies, P2P loans, and oil and gas projects.  Some other excellent points in the letter include:

“This comes down to some of the basic principles upon which our country was founded. The Declaration of Independence states; “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. While it is understandable that we would like to protect individuals that might not have the financial sophistication and/or investment experience from undertaking investments that might not be appropriate for them. The accredited investor rule denies the majority of the population two of these three rights, the rights of Liberty and the pursuit of Happiness. This is not protecting these investors, this is denying them the ability to be investors.”

and…

“These are individuals that might have little or no knowledge regarding equities, commodities or FOREX, but they know that their uncle already has two very successful restaurants and needs some money to fund the opening of a third. They know that they were right to spend a fortune sending their daughter to that Ivy League school, and now they want to help her set up her own medical practice, and get a return on the investment they already made in her education. They know that their best friend is the smartest person they have ever met, and all the years she spent immersed in the Seattle tech startup scene prepared her to launch her own startup with an idea for a product that solves a huge problem that people have now.”

So what can you do about this?

1.  Submit a comment to the SEC.

  • The easiest and fastest way is to send an email to rule-comments@sec.gov.
    • On the subject line include: File Number S7-06-13
    • Unless you want to send your own comments, you can copy and paste the comment below:

Dear SEC,

In regards to request for comments on Section V of Proposed Rule, Release No. 33-9416, items 96, 97 and 99:

I believe the SEC should remove completely the accredited investor requirements or adopt knowledge/experience based standards for an individual to become an accredited investor.

While I can appreciate and understand the concern to protect investors, I absolutely cannot reconcile the use of what equates to financial discrimination as an appropriate tool to achieve such results.  The thresholds for income and wealth, at best, seem arbitrary and biased towards those who already have wealth.

In an environment where many Americans already feel like the deck is stacked against them, where wealth begets special privileges, where markets and the government rules that control it seem less and less egalitarian;  this rule only exacerbates the sentiment.

The right to invest should be just that, and not a privilege available only to those with means.  Again, I kindly urge you to consider in earnest the  complete removal of the accredited investor requirements or adopt knowledge/experience based standards for an individual to become an accredited investor.

Protecting investors is an important function of the SEC, excluding many Americans from investing in private companies is not.

2.  Contact your elected official

  • You can find out who your elected officials are at http://www.commoncause.org.
    • Just type in your address and it will show you who they are.
    • The easiest way to contact them will be to send them an email.  Most have an online form to contact them.  Again, either you can send in your own comments or you can copy and paste the following:

I would like to know your position on SEC proposed rulemaking on Reg D Rule 156 and the definition of an accredited investor, under SEC File No S7-06-13, Release No. 33-9416, Section V.

The SEC is currently considering changes to the definition of an accredited investor.  I would like to see that the rules are changed to allow average Americans the opportunity to make investments regardless of what their income is or how much they have in their bank account.

While I can appreciate and understand the concern to protect investors, I absolutely cannot reconcile the use of what equates to financial discrimination as an appropriate tool to achieve such results.  The thresholds for income and wealth, at best, seem arbitrary and biased towards those who already have wealth.

In an environment where many Americans already feel like the deck is stacked against them, where wealth begets special privileges, where markets and the government rules that control it seem less and less egalitarian;  this rule only exacerbates the sentiment.  The right to invest in private companies should be just that, not a privilege available only to those with means.

Protecting investors is an important function of the SEC, excluding many Americans from investing in private companies is not.

I would like to see your office submit comments to the SEC showing support for working Americans on this.  I would like to see your office show support to either completely remove the accredited investor definition or make a change that allows anyone with a reasonable, but not burdensome, level of knowledge to make their own investment decisions without government deciding what is suitable.

Sincerely,

3.  Engage your Social Network

  • Share this with your friends and family and ask them submit comments.
  • Raise awareness by sharing this on your Twitter, Facebook and other social accounts.

While this may seem like a mundane issue, it boils down to freedom and equality.  The freedom to take control and responsibility of one’s financial future without facing an arbitrary rule that limits one’s investment options.  It boils down to ALL Americans having EQUAL access to investment options, regardless of income or wealth or some other paternalistic notion of “suitability”.

So again, as I said earlier, Mr. Renton’s comments that “the playing field is level” are patently not true and I sincerely hope we can force a change.

About Jose Velez

I received my degree in economics and finance from the University of Texas at Dallas School of Economic, Political and Policy Sciences in 2006. Since then I have worked within the energy industry focusing on regulatory and environmental issues.
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