February 25, 2002
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
File No. S7-23-01
Release No. 33-8041 - Proposed Rule 146(c): Defining the Term "Qualified Purchaser" under Section 18(b)(3) of the Securities Act of 1933
Dear Secretary Katz:
This letter is the Massachusetts Securities Division's (the "Division") response to the Securities and Exchange Commission's proposal to define the term "Qualified Purchaser" under Section 18(b)(3) of the Securities Act of 1933. Under this Section, securities sold to a Qualified Purchaser (as defined) would be covered securities. The states would be pre-empted from requiring that these securities be registered under their blue sky laws.
Under the National Securities Market Improvement Act of 1996 ("NSMIA"), Congress authorized the Commission to define the term "Qualified Purchaser" under Section 18(b) of the Securities Act of 1933 to include "sophisticated investors, capable of protecting themselves in a manner that renders regulation by State authorities unnecessary." Sales to these Qualified Purchasers would be transactions in federal covered securities.
The Commission proposes to define Qualified Purchaser to mean, "accredited investor" as defined in Rule 501(a) of Regulation D. For individuals, the term accredited investor includes a natural person with an income in excess of $200,000 (or joint spousal incomes of $300,000) for the two most recent years, if they reasonably expect to earn at least the same amount in the current year. A natural person with a net worth over $1 million is also an accredited investor. Investors other than natural persons are accredited if they have more than $5 million in assets, or if they are financially sophisticated by their nature (e.g., various institutional investors and employee benefit plans where sophisticated fiduciaries make investment decisions).
Many Unsophisticated Investors Meet the Individual Standard for "Accredited Investor."
Using the definition of accredited investor for individuals, particularly the $1 million net worth test in Rule 501(a)(5), sets too low a standard for being a Qualified Purchaser. In our regulatory experience, it is possible for an individual to meet this net worth threshold, and nonetheless be an unsophisticated investor who would benefit from the protections provided by registration or exemption under state law.
We note that the dollar thresholds for individuals to be accredited investors under Section 501(a) of Regulation D were set 20 years ago and have not been adjusted to take onto account inflation or the growth in the value of the assets many individuals own. We have seen the net worth of many investors increase significantly since 1982, as the value of certain widely held investments has risen. For instance, at the end of 1982 the closing price for the New York Stock Exchange Composite was 81.03; it recently closed at 568.28. The Standard and Poor's 500 Composite Index was at 140.64 at the end of 1982; today it stands at approximately 1092. In 1982, the median price of a house in the Northeast region was $63,500; in 2000, the median price was $139,400. In 2000, the median price of an existing one-family home in the Boston metropolitan statistical area was $314,000.
As a result of the growth in the values of these types of assets, there is a now a far larger group of individuals with a total net worth exceeding $1 million than there was in 1982. However, even as the value of their assets has grown, these individuals have not necessarily become sophisticated about finance and investing.
The Division urges that the $1 million net worth test for accredited investors makes the definition of Qualified Purchaser over-inclusive. A large number of unsophisticated people, including elderly investors who own homes that have appreciated significantly in value, fall into this category, along with holders of appreciated retirement plan assets and holders of the proceeds of insurance policies. Our observation as regulators is that elderly investors with accumulated significant savings are among the most vulnerable and least sophisticate investors in the marketplace, in spite of their sometimes significant net worth. We expect that the regulatory experience of the Commission's Division of Enforcement has been consistent with ours.
The Function of State Securities Registration Requirements.
The securities offerings that the Division reviews are primarily stock offerings that will not be listed on the Nasdaq National Market or an exchange, and financial products such as direct participation programs. We review these offerings using the NASAA multi-state guidelines.
The Massachusetts securities registration requirement requires that offerings either be registered or properly exempt, with the result that many transactions are channeled into the exemptions. The Massachusetts exemptions often include conditions on their availability; for example, the private offering exemptions include "bad boy" disqualifications that make the exemptions unavailable for offerings involving securities law violators.
The Massachusetts securities registration requirement also gives our Enforcement Section a powerful tool to shut down abusive and fraudulent offerings. The Enforcement Section can quickly shut down an unregistered (non-exempt) offering the same way a police officer can take an unlicensed driver off the road. This is consistent with the Commission's use of Section 5 of the Securities Act of 1933, in an enforcement context, to shut down unregistered public offerings.
If the Commission adopts accredited investor as the standard for Qualified Purchaser, the protections of the state registration and exemption system, including the ability of the states to take quick action against unregistered offerings, will be lost for investors with over $1 million in total assets.
Recent Patterns of Abuse in the Marketplace.
Massachusetts, along with other states, has seen an increasing number of securities offerings made under a claim of the Regulation D, Rule 506 exemption. In many cases, these transactions have involved non-accredited investors who appear not to have investment sophistication, apparently contrary to the requirements of Rule 502(b)(2); and many of these transactions appeared to involve general solicitation of investors, contrary to the requirements of Rule 502(c). Our concern about these purported Rule 506 offerings is heightened because these offerings are often sold by unregistered selling persons, who claim to be non-broker finders (who do not comply with NASDR Conduct Rules). Because unregistered persons often sell these offerings, both the securities being sold and the retailing of the securities escape regulatory oversight.
Because the definition of accredited investor is over-inclusive, and includes individuals who do not have the sophistication to protect themselves in the securities marketplace, we urge the Commission not to adopt Rule 146(c) as it is now proposed.
We note that Congress did not use the term "accredited investor," which was already defined in Section 2(a)(15) of the Securities Act of 1933 and SEC rules to describe the kind of purchasers who would give rise to a transaction in covered securities under NSMIA. Because Congress did not use this well-established term, we infer that the Congress did not intend to set the bar of preemption as low as the Regulation D definition of accredited investor.
We are mindful of the Commission's desire to act in a manner consistent with the intent of Congress in defining "Qualified Purchaser." We could support a definition of Qualified Purchaser that did not capture otherwise small investors and saver who hold $1 million in total assets.
NASAA has suggested a Qualified Purchaser standard of $1 million in investments (to be defined in accordance with 17 CFR sec. 270.2a51-1(b)) or $2 million net worth (to be defined in accordance with 17 CFR 230.501(a)(5)). Massachusetts would be supportive of this proposal or another approach that would not undercut the ability of the states to protect the interests of less sophisticated investors with accumulated savings.
Massachusetts Securities Division