Giving Accreditation Where Accreditation is Due

The SEC recently proposed changes to its rules for accrediting investors “to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in our private capital markets.”  In addition to some changes that would primarily affect cash-rich entities like family offices, the new rules would let certain people “qualify as accredited investors based on certain professional certifications and designations” even if they do not meet the strict requirements for funding expected or on hand that the current regime mandates. What does this pending change mean for finance as a whole and for emerging technologies like blockchain in particular? Though the new rules have not yet been defined nor come into effect, the prognosis is good for markets and for individuals alike. 

The current selection criteria for accreditation are well-intentioned but not appropriate for the changed economy of the twenty-first century. The current system is a test of wealth and income that assumes, without justification, that anyone who passes can make sophisticated investment decisions and invest in private companies or funds. There’s an argument to be made that the risk in such investments is higher than the risk in investing in public funds or companies that adhere to SEC restrictions, and that therefore only people with sufficient wealth to gauge larger risks should be permitted. This logic would be more convincing if there were restrictions on how much an accredited investor may put in a private entity. There aren’t active shields against risk: A “sophisticated” accredited investor may, if they so desire, place all their assets in a single high-risk project. 

Another unfortunate effect of the existing system is that the majority of accredited investors are older, as they’ve spent decades accruing wealth or achieving high compensation. Younger people who are capable, educated, and informed but lack sufficient funds cannot participate. In some cases, particularly relating to emerging technologies like blockchain, younger investors may be better judges of investment, with intimate knowledge of risk and reward, of competition and challenges. Older investors may find it more difficult to correctly assess risk, especially when investment opportunities are presented by swindlers. The proposed education criteria would effectively close the age gap. For the first time, younger and motivated people could be allowed to participate in private capital markets.

Some sectors of the private markets may not change much. Private equity, for example, usually opts to rely on fewer and larger limited partners. Private companies may see more young angel investors, though most companies prefer simple cap tables and investors with strategic capabilities. Blockchain and emerging technology projects, by contrast, stand to benefit. Their goals when selling tokens to investors include truly decentralized token distribution and the creation of a knowledgeable, participating community. Young investors are more likely to know about blockchain, and they have fewer assets, so a larger pool of investors is needed. Blockchain combines such disciplines as economics, computer science, game theory, organizational theory and distributed systems; its most ardent proponents are often young people with fresh perspectives and a willingness to throw out the old models. They know what they want to invest in, they know how they want to do it, and they’re just waiting for the SEC to let them.

The new rules have not been approved yet; they’re still undergoing the public comment and vetting process that is normal and expected for regulatory changes in the United States. If the rule passes muster with the public and the markets and is approved, the SEC will have made a great stride forward. The new education rule would let informed and conscientious investors participate in the markets they already understand while opening new sources of funding to companies and institutions. The proposed new rules for accreditation should be applauded and encouraged. They make the financial world bigger and better for all.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

SOURCE : NASDAQ

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