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SEC is wrong saying few Accredited Investors will behave like Accredited Investors

We read with interest the Economic Analysis section of the Commission’s final rule eliminating the prohibition against general solicitation and advertising in Rule 506 and Rule 144A offerings.

We think the rule is a good one notwithstanding that its critics have valid concerns that must be addressed by the SEC, and which inevitably will also be addressed by market forces.

But, there is one thing we disagree with.  At pages 101-102, the Analysis states:

Our analysis, however, leads us to believe that only a small percentage of these households are likely to participate in securities offerings, especially exempt offerings. 

First, as mentioned above, data from Form D filings in 2012 suggests that fewer than 234,000 investors (of which an unknown subset are natural persons) participated in Regulation D offerings, which is small compared to the 8.7 million households that qualify as accredited investors [based on the net worth standard]. Second, evidence suggests that only a small fraction of the total accredited investor population has significant levels of direct stockholdings. Based on an analysis of retail stock holding data for 33 million brokerage accounts in 2010, only 3.7 million accounts had at least $100,000 of direct investments in equity securities issued by public companies listed on domestic national securities exchanges, while only 664,000 accounts had at least $500,000 direct investments in such equity securities … Assuming that investments in publicly-traded equity securities are a gateway to investments in securities issued in exempt offerings, and accredited investors with investment experience in publicly-traded equity securities are more likely to participate in an exempt offering than accredited investors who do not, the set of accredited investors likely to be interested in investing in Rule 506(c) offerings could be significantly smaller than the total accredited investor population.

First, the Report is based on an analysis of 33 million brokerage accounts but there is no way to know how many of those accounts were owned by accredited investors.

Second, there is no logical reason to assume, as the Report does, that “investments in publicly-traded equity securities are a gateway to investments in securities issued in exempt offerings, and accredited investors with investment experience in publicly-traded equity securities are more likely to participate in an exempt offering than accredited investors who do not…”  Someone with significant holdings in mutual funds may be every bit as (and even more) sophisticated about financial matters as someone with significant holdings in specific stocks.

Third, the report ignores some very basic facts that cannot be found in the statistics relied upon in the Report.  The fact of the matter is, as stated in the September 2012 report, How alternative investments are going mainstream, McKinsey & Company (and as AIMkts wrote about on July 9th), “[l]ong the preserve of institutional and high-net-worth (HNW) investors, alternatives are moving into the U.S. retail mainstream as individuals, confronted with volatile financial markets and retirement savings gaps, seek wider options. Investment managers are enabling this trend by making products more accessible, packaging alternative investment strategies into regulated mutual funds and ETFs (and UCITs in Europe), and selling them through traditional retail distribution channels.”

As we have suggested before, knowledge is power.

Now that the ban prohibiting general solicitation and advertising will be lifted and a multitude of funding platforms will be competing for investors’ dollars, more and more accredited investors will invest securities offerings.   Will this happen overnight?  No.

However, just as far more Americans own stock today before the age of the discount broker, on-line trading, and the Beardstown Ladies Investment Club (though, while it helped bring awareness to the masses that that stock market investments are not limited to the ultra-wealthy, its saga also can serve as a cautionary tale to people that one should not always believe what she reads), so will the lifting of the ban help knowledge flow.

Some percentage of accredited investors will make the informed decision to allocate some of their money to alternative investments, and that demand will beget more supply, and so on.

The genie is out of the bottle.

About Adam Schlagman

Adam has served for the past 17 years as editor-in-chief of four titles for Law Journal Newsletters, a division of American Law Media. He is also a licensed attorney.

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