Securities Lawyers Blog
This article continues to opine on an InvestmentNews article, describing the Securities and Exchange Commission’s (SEC) revisiting the accredited investor standard that determines who is eligible to invest in private placements. It is the opinion of this securities attorney who has represented hundreds of cases involving investors in private placement offerings that some of the IAC’s proposals are severely flawed and will only enrich the industry at investor’s expense. While proposals to increase standards through sophistication tests and limiting the amount of private placement investments to a certain percentage of net worth are constructive, it is clear that some will attempt to use the review to water down the current requirements. Below are some of the reasons why proposals to abandon the income and net worth approach and instead use a definition that takes into account an individual’s education, professional credentials, and investment experience will be a disaster for investors.
First, many private placements such as equipment leasing and non-traded real estate investment trusts (Non-Traded REITs) already skirt these rules and offer non-traded investments to those with income of $70,000 and net worth of $250,000. If you want to see what the world would be like without the $1,000,000 constraint on private placements, it’s already here and it’s not pretty.
Non-Traded REITs are a $20 billion a year industry that basically ballooned overnight. These non-traded investments act like private placements and charge anywhere from 7-15% of investor capital in the form of commissions and selling fees. In addition, there is little evidence to support that these investments will largely be profitable for investors. In fact, because non-traded REITs offer products with very limited income and net worth thresholds brokers have loaded up clients accounts to such an extent that the NASAA has proposed universal concentration limits to curb these abusive practices. But as bad as many of these products are, many other private placements that would be allowed to be sold to investors under some of the IAC proposals are far worse.
Second, the largest threat to investors is the IAC’s proposal is to grant the brokerage industry the ability to recommend private placements based upon the industries own subjective assessment of the investor’s sophistication. It has been my experience that the industry, in many cases, doesn’t accurately gather investor suitability information from their clients and is inherently conflicted in the information gathering process. In reality, some brokers select the investor’s sophistication and risk tolerance based upon the investments the broker desires to sell instead of the investor’s actual investment acumen and goals.
Indeed, in some cases we have handled investors are given new account forms to sign several months after signing the original forms and like magic, the investor doubles their investment experience overnight, has higher risk tolerance, increased assets, and are now ready to load up on private placements. In sum, subjective criteria is useless for investor protection. Without any assurances for the integrity of the information gathering process such criteria will become an easy license to sell. Who needs to go through the hassle of the current system by inflating an investors assets when the broker can merely form an opinion as to the investor’s sophistication.
Hopefully the SEC will view these proposed changes from the investor’s prospective and what an unscrupulous person might do to circumvent the rules. Lets remember that Wall Street fights the fiduciary duty standard but salivates at the opportunity to alter the private placement investor standards, need we say more. It may very well turn out that the flaw in Dodd-Frank was that it opened the private placement box to begin with. By opening the door the industry will flood in and water down the rule until its useless and a law that was meant to strengthen investor protection could ultimately be used to weaken it.