They're Shorting Market Freedom at the SEC

They're Shorting Market Freedom at the SEC
(AP Andrew Harnik, File)
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A reason so many Americans worry about the administrative state is that federal agencies add rules without giving sufficient consideration to the effect of the regulatory action on personal liberty. Government regulation seems to grind on, at the constant expense of individual freedom. A recent decision by the Securities and Exchange Commission to amend the “Accredited Investor” definition brought this to mind.

The SEC action involved amendments to the categories of individuals permitted to invest in a type of private offering of securities authorized by an SEC regulation. Private offerings under this rule are different from the public offerings familiar to most investors. One big difference is that the private offerings are not open to the public. With only minor exceptions, buyers in these offerings must be accredited investors, meaning individuals with sufficient net worth or income or certain institutions, such as banks, insurance companies, and broker-dealers.

The ability to buy in these private offerings is desirable. They dominate as the method of raising capital in the United States. In 2019, the amount raised under this SEC regulation was $1.56 trillion, and the amount raised in public offerings was $1.2 trillion. The offerings also are popular with technology and other startup companies in their high-growth stage before they issue stock to the public. Non-accredited investors are therefore cut out of a large, potentially lucrative segment of the securities market.

Originally, a buyer in a private transaction needed to have detailed knowledge about the company selling the shares. Over time, the SEC refashioned the definition of accredited investors so it no longer depended on knowledge about a company. Now the SEC’s standard for an individual to be an accredited investor is that he or she must have sophistication and experience with financial investments or the ability to lose money.

That led to the SEC’s recent amendments to the definition of accredited investors. The SEC supplemented wealth tests for individuals with a financial expertise test. The newly admitted were registered or licensed investment advisers, certain types of licensed investment professionals employed by registered broker-dealers, and, when buying a security of the fund, executives and employees of hedge funds and private equity funds who participate in the investment activities of the fund. The accredited investor definition for individuals now includes the wealthy and the privileged financial classes.

The SEC’s recent amendments slightly increased the number of individuals able to invest in the private transactions, but the decision to keep the accredited investor category and bring certain financial professionals within it was problematic. The result perpetuated the exclusion of average investors from a wide range of investment opportunities.

This classification of investors into favored and disfavored classes is the kind of governmental line-drawing activity that detracts from individual liberty. Ostensibly, the SEC goal was to protect non-accredited investors from risk, but the agency inadequately weighed protection of the freedom of individuals to choose investments for themselves, bear responsibility for those choices, and assert control over how they spend their own money. Instead, the government took choice away and mollycoddled people who want to determine their own financial futures. Inevitably, as the SEC fiddles with accredited investor definitions based on sophistication, financial acumen, wealth, or ability to bear a loss, the result is greater government intrusion into personal information and private decisions to allocate capital.

At the time of voting on the new amendments to the accredited investor definition, one of the SEC Commissioners, Hester Peirce, unsuccessfully expressed concerns about denying non-accredited investors the freedom to invest in private companies. “Why shouldn’t mom and pop retail investors be allowed to invest in private offerings? Why should I, as a regulator, decide what other Americans do with their money?” Accredited and non-accredited investors alike should have both the freedom and responsibility to make investment decisions for themselves. The government should respect the “liberty interests” of all investors, she said.

A further problem with the SEC’s recent amendments is that they widen the gap between those who are part of the financially entitled and those who are not. Certain employees and executives at hedge funds, broker-dealers, and investment advisers, even if they do not yet have the necessary income or net worth, may now invest in private offerings. They are part of the educated, professional, financial elite, and they now have a regulatory benefit that will help keep them there. The SEC used its legal authority over the definition of accredited investors to concentrate more wealth and opportunity in the privileged financial classes and deny mainstream investors the ability to participate in those investments. Whatever the SEC’s rationale, this outcome is out of step with concerns about wealth and income inequality and efforts to break down artificial barriers to wider financial self-sufficiency.

The SEC did not need to make the decisions it did. Alternatives were available. The SEC could have abolished the category of accredited investors and provided sufficient information to buyers by requiring a set of core company disclosures. This would have promoted the freedom of all potential investors and would not have singled out the financial services industry for special benefits.

A remedy to the larger concern with the constant threat to freedom from regulatory actions is to oblige agencies to consider the liberty implications of proposed regulations. Agencies should adopt a “freedom-enhancing” policy as part of their rulemaking procedures. The extent and severity of restrictions on an individual’s freedom to choose and act should be an explicit cost or burden to be weighed when an agency balances costs and benefits of a proposal that would regulate private behavior. Removing restrictions should be a benefit.

Such a rulemaking policy would be a reminder that agencies, like all of us, must always be alert to protect fundamental national values.

Andrew N. Vollmer is a senior affiliated scholar with the Mercatus Center at George Mason University, former deputy general counsel of the SEC, and former professor of law, general faculty, at the University of Virginia School of Law.

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