It’s Time to Change the Accredited Investor Rule for Private Placements

play at risk.JPGMy California securities law firm has been inundated with inquiries from small investors who were sold unregistered private placements even though they were clearly not wealthy or financially sophisticated. Some of these private offerings–such as those issued by Medical Capital Holdings and Provident Asset Management–turned out to be outright frauds.

The private placements that are causing the most trouble were widely sold by stockbrokers who were only allowed to target wealthy individuals that have the financial capability to bear the risk of investing in unregistered and illiquid securities. These qualified investors are referred to as “accredited investors” under the federal securities laws. As discussed in a previous blog posting about accredited investors, an individual will be considered “accredited” if they have a net worth of $1 million or an annual income in excess of $200,000 (or $300,000 when combined with a spouse). The financial threshold for “accredited investors” was established under “Regulation D” which was adopted back in 1982. These requirements have not been updated since they were implemented 28 years ago. According to an analysis conducted by Businessweek, if adjusted for inflation, the accredited investor net worth requirement would increase from $1 million to $2.25 million and the income requirement would increase to $449,000 (single) and $674,000 (married). It is estimated that there were approximately 1.5 million “accredited investors” back in 1982. By 2008, the estimated number of households that were “accredited” swelled to as much as 7.2 million.

With such a low barrier to entry, many small investors were allowed to unwittingly put their retirement savings at risk–often lured by assurances from their stockbroker of high returns, safety and liquidity. An increase in the accredited investor qualification requirements is necessary to curtail the sale of private placements to individuals who can least afford to lose their investment.

See related blog posting:

UPDATE: Investor Home Equity to be Excluded from $1 Million Minimum Net-Worth Requirement for Accredited Investors

Even for Accredited Investors, Stockbroker Recommendations to Buy Private Placements Are Subject to the Suitability Rule