August 14, 2010
The recent changes to the definition of an Accredited Investor will do very little to prevent fraud or protect consumers. The changes to the definition amount to nothing more than a cosmetic adjustment to an already flawed law.
Liquid Net Worth is a poor indicator of investing sophistication. Older investors, who have had a long time to accumlate wealth, do no necessarily possess better investment acumen. Younger investors, who have not had the time to build up substantial liquid wealth, are often far more capable of evaluating risk and making corresponding investment decisions.
The hurdle for becoming an Accredited Investor should be tied to Liquid Net Worth only to limit -- not restrict -- the type of risk an individual investor is allowed to take. Accredited status should be afforded to investors on the basis of two criteria:
1) Investor Sophistication - which could be measured by issuing a standardized test to would be Accredited Investors and
2) Limitations on the amount of one's Liquid Net Worth that can be invested in deals that are not under their direct control.
Requiring investors to prove their level of investing sophistication will have multiple benefits. First, it encourages investors to focus and think about the investment risks they incur by investing in private securities transactions. Secondly, it has educational benefits to society. Thirdly, it will help advisers evaluate the sophistication of their clients, which, in turn, helps them provide more relevant investment advice. And, lastly, it creates an investing public that is more capable of detecting and reporting fraud.
Limiting the exposure that an investor can take in individual, non-control private securities transactions will ensure that even if fraud occurs, its impact will be limited to only a certain proportion of an investor's liquid net worth. It will also minimize losses from individual deals and force investors to diversify, even among their private securities transactions.
In cases where an individual investor does not possess the sophistication to achieve Accredited Status, advisors who achieve a special private securities transaction status could be enlisted to help that investor so they could participate in private security investments. The limitation rule would still apply.
The benefits to society of this suggestion would be far greater than the current blunt tool that is currently in force. Simply put, the American investing public needs greater sophistication -- an uptick in the quality of thought if you will -- from its Congress and its largest regulatory agency, the SEC.
Mark A. Buffington