Monday, June 18, 2012

Why Accredited Investor Requirements Don't Measure Financial Sophistication

With all of the excitement about the JOBS Act and the legalization of selling equity in private companies to unaccredited investors, I have to ask the question: Does qualifying to be an accredited investor really qualify someone to make better investment decisions than someone that is not?

Here is the definition of an accredited investor: he/she makes more than $200,000 per year or has a net worth of more than $1 million, exclusing personal residence. I have met a lot of people that meet this requirement that have and continue to make horrible investment decisions. So why are income and net worth the only requirements? Probably because just about any other requirement would be too hard to measure.

The accredited investor requirements are exclusionary. Before the SEC Act of 1933, anyone could sell and buy stock in any company to anyone else. The income and net worth threshold set by the 1933 Act exclude some who are probably really smart, but the Act takes the position that it's better to exclude them and only allow those with money to lose to be accredited.

It's faulty logic, and it is at the core of the CrowdFunding movement. In January of 2013, when equity and debt-based CrowdFunding become legal, unaccredited investors will no longer be excluded from buying stock in privately-held companies that crowdfund. Unaccredited investors will have annual limits they can put into crowdfunded companies, but at least they can get into the game.