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From Securities Regulation Daily, June 16, 2015

House subcommittee mulls bill seeking wider accredited investor definition

By Mark S. Nelson, J.D.

The House Financial Services Committee’s Subcommittee on Capital Markets and Government Sponsored Enterprises heard testimony from business groups and academics on a pair of bills that would expand the types of people who can be accredited investors and ease the regulatory burdens on business development companies (BDCs). Lawyers as a group had to endure some perhaps less than good-natured ribbing over whether their professional training makes them financially sophisticated enough to be accredited investors under one of the proposed bills.

While much of the hearing's question and answer session focused on the BDC bill, it is the bill proposing to change the definition of accredited investor that will likely capture the investing public’s imagination. The debate over whether and how to change this definition has repeatedly drawn the attention of the SEC’s industry outreach committees that advise the Commission on possible legislative and regulatory changes. The accredited investor definition also is critical to implementation of a few provisions in the Jumpstart Our Business Startups (JOBS) Act and to enactment of a follow-on package of bills known informally as JOBS Act 2.0 legislation.

Accredited investors. The Fair Investment Opportunities for Professional Experts Act (H.R. 2187), introduced by Rep. David Schweikert (R-Ariz), would direct the SEC to alter Securities Act Regulation D to provide that a natural person is an accredited investor if he certifies to an issuer before any securities are sold to him that he is a registered broker-dealer, SEC-registered investment adviser, a licensed attorney, or a certified public accountant.

A person also could meet the new definition by certifying that he has hired one of these types of professionals to make an investment or that he is a Financial Industry Regulatory Authority, Inc. (FINRA)-licensed accredited investor. This latter option would require the person to take an examination to be administered by FINRA using criteria set by the SEC. Rep. Schweikert’s bill would have the SEC focus on criteria dealing with a person’s knowledge of the various types of securities, differences between public and private company securities disclosures, corporate governance structures, and the key features of financial statements.

Scott Garrett (R-NJ), Chairman of the House Capital Markets subcommittee, said both the accredited investor and BDC bills aim to modernize the securities laws to encourage more economic activity. He noted that the BDC law was last updated long ago, and that the SEC could limit accredited investor status to even fewer individuals.

Meanwhile, Carolyn Maloney (D-NY), the subcommittee’s ranking member, noted the BDC bill is akin to one from the 113th Congress, albeit with some improvements. She also noted that while accredited investor status presumes the ability of individuals to bear risk, Congress should ask if it has struck the right balance. Representative Maloney said the SEC’s Investor Advisory Committee’s recommendation could be a starting point for discussions.

Although not testifying today, William Beatty, President of the North American Securities Administrators Association (NASAA) and the Washington Director of Securities, wrote to Rep. Garrett and Rep. Maloney to express general support for refining the definition of accredited investor, while pushing Congress to be cautious about how it achieves this result.

Beatty’s letter urged Congress to await the SEC’s review of the accredited investor definition, and to get more data on the still opaque Regulation D private placement market. Beatty said Congress also should press the Commission to finalize the Regulation D changes it proposed in 2013. But Beatty said NASAA also worries about the “self-certification” aspect of the proposed bill, and the potential that many customers of broker-dealers could suddenly become accredited investors.

Dodd-Frank Act Section 413 directed the SEC to review the definition of accredited investor. SEC Chair Mary Jo White confirmed in her May 2015 testimony to the House Appropriations Committee’s Subcommittee on Financial Services and General Government that the Commission staff is conducting that review.

SEC Commissioner Michael S. Piwowar recently spoke about how current accredited investor rules describe an investment regime beset by a “capital restricted” approach versus the “capital unbound” motif of the Cato Summit on Financial Regulation, where he delivered his remarks. Piwowar questioned whether inflation adjustments or other tweaks could truly improve the definition of accredited investor or whether they may simply reinforce existing risk-return trade-offs while limiting who can use high-risk high-return securities to partake of modern portfolio theory. He said the protective goals of the existing definition may perversely bolster the wealth divide in the U.S.

The SEC’s Investor Advisory Committee has focused on a range of questions, including the impact of inflation on the existing accredited investor definition (it has not been updated since 1982), and whether a revised definition should look beyond an individual’s financial prowess to professional or other educational proficiencies. The committee made a recommendation to the Commission last year.

The accredited investor concept flows from the Supreme Court’s 1953 Ralston Purina opinion in which the justices posited a two-speed world of investors in securities offerings—those who can fend for themselves with little, if any, explicit regulatory safety net, and those who cannot. Rule 501 of Regulation D confers accredited investor status on any natural person who has a net worth of $1 million or has an income over $200,000 (or joint income with a spouse of more than $300,000).

Easing burdens on BDCs. The Subcommittee on Capital Markets also mulled the Small Business Credit Availability Act, to be introduced by Rep. Mick Mulvaney (R-SC), which is designed to ease regulatory burdens on BDCs. This would be achieved by revising the Investment Company Act and directing the SEC to revise 17 rules under the Securities Act and the Exchange Act. Representative Mulvaney’s bill also would let BDCs act as if the SEC made the required rule changes if the Commission does not act within the prescribed time limit, at least until the SEC in fact adopts the freshened rules.

Representative Maloney asked panelists about the BDC bill’s aim of letting BDC’s invest more funds in investment advisers and finance companies.  Vincent D. Foster, CEO and Chairman of Main Street Capital, testifying on behalf of the Small Business Investor Alliance, said the added flexibility the bill offers is not a priority because shareholders might object to a BDC changing its investment strategy. But Foster acknowledged it might be nice for BDCs to have the ability to invest in financial firms, even if it is seldom used.

Michael J. Arougheti, Co-Chairman and Executive Vice President at Ares Capital Corporation, noted that the structure of financial markets has evolved significantly over the past 30 years. But J. Robert Brown, Jr., law professor and Director of the Corporate and Commercial Law Program and University of Denver’s Sturm College of Law, and Secretary of the SEC’s Investor Advisory Committee, said he worried about funds from operating companies being diverted to financial firms, which have lesser funding needs than do operating companies.

A later exchange between Rep. Bill Huizenga (R-Mich) and Tom Quaadman, Vice President of the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce, explored the differences between the current draft BDC bill and one from the last Congress. According to Quaadman, the new BDC bill has a ceiling that did not exist in its prior versions. Quaadman also noted that most BDC funding would still go to operating companies.

Representative Mulvaney, who appeared by invitation because he is not on the Capital Markets subcommittee, addressed concerns about shifting BDC funding to financial companies. He explained in prefatory comments to his questions to the panelists that his home state depends on community banks and his BDC bill is an attempt to make new funds available via these banks for economic expansion. He also said the likely recipients of these funds would be less leveraged than many operating companies.

Fiduciary duty worries some. Today’s hearing was primarily about enhancing capital formation, although it sometimes drifted into a discussion about how to upend portions of the Dodd-Frank Act. Representative Bruce Poliquin (R-Me) asked the panelists which Dodd-Frank Act regulation they would most like to see repealed.

A few of the panelists replied to further prompting by Rep. Poliquin about the Department of Labor’s (DOL’s) recently proposed fiduciary duty rule. While Arougheti and Foster said the DOL rule could have some impact if adopted, Quaadman said that investment advisers are “concerned” about the proposal. Quaadman cited last week’s report by the U.S. Chamber of Commerce suggesting that the DOL’s proposed fiduciary rule could limit the investment options for nine million employees.

Companies: Financial Industry Regulatory Authority, Inc.; North American Securities Administrators Association; Main Street Capital; Small Business Investor Alliance; Ares Capital Corporation; Center for Capital Markets Competitiveness; U.S. Chamber of Commerce

MainStory: TopStory AccountingAuditing BrokerDealers DoddFrankAct FINRANews InvestmentAdvisers InvestmentCompanies InvestorEducation JOBSAct NASAANews PrivatePlacements SecuritiesOfferings

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