Recently, the United States Securities and Exchange Commission (“SEC”) adopted an amendment that seeks to expand the inclusion criteria of an ‘accredited investor’. The initial discussion behind this reform comes after the passing of a proposal that was released in December, 2019 which raised concerns against the eligibility criteria of investors towards various securities in detail, and to involve institutional and individual investors that have the capability, knowledge and competence to participate in engagements of private capital markets in the country.
As part of this regulation, the definition of ‘accredited investor’ legislations has been specifically amended - under Rule 501 of Regulation D and that of a ‘Qualified Institutional Buyer’ (‘QIB’) has been amended under Rule 144A of the Securities Act of 1933 (‘Securities Act’). This essentially means that, an accredited investor could be an individual or an entity/institution who is allowed to deal with securities that are not available to the general public in the market. Also, these securities may or may not be registered with any particular financial regulatory authority. A QIB on the other hand, is a purchaser of securities that is deemed to be financially sophisticated and is legally recognised by securities market regulators to need less protection from issuers than most public investors. In essence, the SEC has expanded the criteria of eligibility for such investors in the market, garnering mixed reactions by the stakeholders in this process.
In order to deconstruct and understand the amendment as a whole, we shall be dividing our focus into three categories: a) individual investors; b) entities; and c) QIBs.
a) Prior to the US SEC bringing this amendment , since 1982, the criteria for allowing an individual investor to considered ‘accredited’ included them to possess a minimum annual income requirement of USD 200,000 (two hundred thousand) ( USD 300,000 (three hundred thousand) for a joint investor couple), or at least USD 1,000,000 (one million) in net investments (disbarring their personal residence). In the past, the rationale behind allowing an exclusionary criteria was behind the presumption that ‘rich’/’able’ investors (individuals/institutions) can suffer the burden of risks and losses due to a strong capital backing. However, in the amendment report, as part of the revised eligibility for ‘accredited investors’, the concept of ‘financial sophistication’ has been heavily discussed at various fronts, as it stands as the edifice underneath the concept of an ‘accredited investor’. The committee has amended to place reliance upon additional new factors for ‘financial sophistication’ such as an investor’s assessment of an opportunity at the market, adequate weighing of risks and benefits before an investment, the capability of allocating their wealth wisely, and accessing information about potential issuers, issuances and investment prospects. Therefore, alongside their wealth capability criteria (which remains unaltered), technical knowledge of markets and its functioning will help determine an ‘accredited investor’ in the market. In its essence, the idea behind widening the ambit is to allow the introduction of new investors in the private securities market, and to provide opportunities to many who were unable to avail the same. However, an important point to note is that the SEC has kept the financial criteria just the same since the 1980s, not taking into account the increasing inflation rates. This could lead to drastic effects now, as the market opens up to a wider pool of investors.
b) On the other hand, for entities, the prior requirement was of a full ownership by accredited investors, with the nature of the organization being a corporation, trust, partnership entity or of a similar nature, with assets exceeding USD 5,000,000 (five million). Now, the amendment includes deemed accredited investors to include various categories such as SEC and state registered offices, rural business development entities, entities of familial business nature, entities which function without the idea securities being offered, and foreign entities.
c) The amendment enables investors that meet the USD 100,000,000 (one hundred million) threshold in securities owned and invested to qualify as QIBs. These investors fall into a separate category of investors due to their requirement of lesser protection than other public investors. The SEC now recognises a wider scope of people under this category, regardless of the nature of their legal form of organisation.
The fundamental concerns that arise in the amendment are the practical risks and dangers associated in the securities market that might be easily overlooked/ never come to the attention of a financially/technically modest private investor. Therefore, what may look as a move of inclusion and introduction of private investments by a larger pool could turn out to have potential adverse effects on retail investors and the public markets in the longer run. Shortcomings of this newly adopted amendment could include technical aspects such as increasing income thresholds, considering prior market experience as a metric, and the reconsidering of the ‘sophistication’ criteria with respect to the ability to bear substantial losses and access to relevant market information and data. Some potential failures that this proposal brings could include the facet not recognising the inflation models in the market wisely, and that of enormous amounts of classified/inaccessible market information and knowledge about investments that would not reach the potential investor. On the other hand, for private-capital fund managers, the amendment invites more monetary benefits towards them, providing a potentially larger pool of assets from which they may collect fees.
Another aspect to draw our attention towards is the overall impact of this amendment on the domain of digital assets in the country. At the time of the discussion of the amendment and during the proposal in 2019, no Bitcoin exchange traded fund (‘ETF’) had been approved by the SEC. However recently, the crypto-sceptic SEC allowed the launch of equity shares of Acra U.S. Treasury Fund , a close-ended fund. Many crypto-backed ETFs have the requirement of being an ‘accredited investor’, and this amendment would only allow more people to invest further into the same. Although, the current amendment has been silent on the prospects towards digital asset investments, cryptocurrency stakeholders around the country have received this move positively, due to its general inclusionary nature.
In such a case, it shall be interesting to see how the relevant stakeholders, market functionaries and authorities react to this amendment, and how the various changes play out in the markets practically. Previously, cryptocurrency funds have introduced investment product offerings under Regulation D of the Securities Act, the amendment is likely to lead such companies to offer more such cryptocurrency induced products to a wide range of accredited investors now. Authored by Mustafa Rajkotwala, Officer, Data and Innovations at BlockSuits.
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