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Last Thursday, the SEC’s Investor Advisory Committee met, and on the agenda was a discussion of exempt offerings under Rule 506 of Regulation D and the definition of “accredited investor.” This discussion comes about when the SEC has had “Regulation D and Form D Improvements” on the Reg Flex Agenda for some time now, and Commissioner Crenshaw caused a stir at this year’s Northwestern Securities Regulation Institute by noting several areas of concern with Rule 506 and the rise of unicorns that utilize the exemption, including those related to investor protection, inflated valuations, corporate governance and the impact on small businesses. Earlier this year, the Investor Advisory Committee also explored the growth of private markets at one of its meetings. This Mayer Brown Free Writings & Perspectives blog describes the proceedings at last week’s meeting:

Panelists examined the increased use of Rule 506 and provided recommendations regarding potential changes to improve information asymmetry and provide better investor protections. Craig McCann noted the increasing popularity of exempt securities offerings: at least $15 trillion of Reg D securities were sold from 2009 through 2020, compared to $16.4 trillion of registered securities sold and at least $4.4 trillion of Reg D securities were sold in 2021 and 2022, 13% more than the $3.9 trillion proceeds from public offerings. Panelists further discussed the background, purpose and effect of Form D filings and noted that Form D filings are intended to provide notice of exempt offerings and to allow the SEC to collect empirical data on these filings. However, while a Form D filing is a rule requirement, it is not a condition to the exemption. Panelists noted that some issuers may not make Form D filings, causing the data available to the SEC to be incomplete. Additionally, panelists discussed how Form D filings themselves can sometimes be a vehicle for fraud, as some investors do not understand that Form D filings are not reviewed and assessed by SEC staff and that the SEC stamp on the form can provide the contents therein with legitimacy for investors. Potential suggestions from panelists to alleviate these concerns would be to include a link on Form D filings to standard risk disclosure regarding start-ups already readily available on the SEC’s website, including a statement on Form D that the contents are self-reported or including a legend with standard risk disclosure on the form. Last, panelists suggested the SEC examine its rules and regulations covering the public market in order to make the market more accessible.

The Investor Advisory Committee also took up the topic of the accredited investor definition. The agenda for the Investor Advisory Committee stated that “under current securities regulations, individuals qualifying as “accredited investors” are permitted to invest in unregistered securities that, by nature, lack many of the protections provided by the regulatory disclosure requirements and attendant accountability through traditional public markets. Over the years, the SEC has continued to evolve standards on these qualifications, with the overarching goal of ensuring ‘accredited investors’ possess sufficient financial sophistication and necessary financial resources to participate in these inherently riskier and often highly illiquid markets.” On this topic, the Mayer Brown blog notes:

Panelists discussed the origins and intent of the “accredited investor” definition and considered whether the “accredited investor” qualifications remain fit-for-purpose. The panel explored whether updates to the rule may be necessary to ensure the SEC can balance the needs of investors through its tripartite mission of investor protection, ensuring fair, orderly, and efficient markets, and facilitating capital formation. While providing a background of the current “accredited investor” framework, Professor Usha Rodrigues cited stating the SEC’s 2015 Report on the Review of the Definition of “Accredited Investor” stating, “the accredited investor definition is a cornerstone of Regulation D” and “the concept intended to encompass those persons and entities whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protection of the Securities Act’s registration process unnecessary.” The panelists discussed the growing number of persons captured by the definition of “accredited investor” – 2% in 1982 and over 10% today. Multiple panelists further noted that wealth is not a proxy for financial sophistication and that accredited investors should possess both financial sophistication and wealth to allow them to better assess investment opportunities and isolate themselves from potential losses. Some suggestions proposed by panelists to limit the number of persons falling within the definition of an “accredited investor” include: excluding retirement income from the calculation of wealth; adjusting income levels for current inflation and including a financial acumen threshold; and including tiered pathways to participation for various Regulation D offerings.

It remains to be seen whether the Commission will have the bandwidth to propose changes to Rule 506 in the coming months. Reading the tea leaves a bit, the Investor Advisory Committee’s consideration of this topic may indicate that a proposal is closer to seeing the light of day. My only hope is that the Commission will choose to tread lightly here, given that Rule 506 is such an important linchpin of the capital markets.

– Dave Lynn