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KMW Blog Sep 7, 2016: Crowdfunding movement launches attack on accredited investor rule as elitist

Posted: Sep 7, 2016JK: Crowdfunding movement launches attack on accredited investor rule as elitist
Published: Aug 1, 2016HP: Death to the Accredited Investor Rule
Jorge Newberry of the Huffington Post has written a blog post which attacks the SEC's accredited investor rule as an unjust obstacle that prevents the 99% from participating in potentially higher yielding investment opportunities which by virtue of a financial standard are reserved for 1% of the population. Newberry takes his lead from a white paper published in 2016, The Renaissance of the Retail Investor, whose authors argue the US capital markets are monopolized by institutional investors, with small businesses and non-accredited investors (retail investors with less than a $1 million net worth excluding primary residential real estate equity, or reliabily making $200,000 or more income annually) excluded from "alternative" and "private" assets. The authors are involved with crowd-funding initiatives, so it is understandable that they would like to see the accredited investor threshold signficiantly lowered or eliminated altogether. The white paper warns that in contrast the SEC is contemplating changes that would raise the accredited investor threshold. The standard argument from financial regulators and cartels is that wealth is a measure of success and competence, and those individuals who have failed to achieve a certain level of wealth must be protected from the predations of those who have. Equating wealth with competence and the capacity to resist fraud is an arrogant concept. The argument that the 99% must be protected from high risk, high reward investments through vehicles such as private placements is nonsense because for the argument to be consistent the 99% should be forbidden from buying individual company equities in the open market, gambling in casinos, or buying lottery tickets. What makes the white paper and Huffington Post blog refreshing is that it comes into the open with the accusation that the accredited investor rule is discriminatory and only serves to foster the growing disparity between an economic elite and the rest of the population.

Some of the Canadian securities commissions such as the BCSC have already taken an important step to lessening the discrimination with the Existing Shareholder Exemption which allows a non-accredited investor to invest up to $15,000 per company per 12 month period in a private placement. The hitch is that the investor must be a shareholder of record when the company announces a private placement, and, of course, it is taboo for a company to signal that it plans to do a financing with this exemption. The paradox is that when it comes time for a junior to raise money, it can under this exemption only access capital from retail investors who probably already own more stock in this junior than they should, or hate the company because they own some rolled back residue from an earlier incarnation that is more expensive to sell than keep. The existing shareholder requirement is a cynical ploy by the regulators to appear to be sympathetic to the cause of greater access to investment opportunities fior retail investors while simultaneously offering an exemption that is difficult to use. The "existing shareholder" requirement also has nothing to do with egalitarian fairness, because only shareholders in the right jurisdictions are entitled to take part in such a private placement. The attempt to make it look like a rights offering is highly misleading. The initial recommendation from the regulators was that a company deal with "over-subscriptions" by cutting everybody back on a pro rata basis, but this needs only be done if the company was stupid enough to promise this mechanism in its news release. Smart companies will say that subscriptions will be accepted on a first come first serve basis until the maximum is done. There is thus nothing democratic about the existing shareholder requirement. Because the BCSC is not run by stupid people it is fair to accuse it of insisting on this requirement in order to look like they care about retail investors and juniors trying to access their risk capital when in reality they are making it very inefficient to do so.

Painful inefficiency is in fact a deliberate strategy pursued by the regulators to discourage retail investors from giving money directly to public companies through private placements rather than buying it in the open market from investment bank operated short selling algo traders and one-percenters who acquired their stock under the accredited investor exemption. They accomplish this by requiring the same paper based documentation required from accredited investors for transactions that are $15,000 or less. This involves printing out 50 plus pages of boiler plate, correctly pulling out the handful on which a box must be ticked or some information added, scanning these, and emailing the resulting pdfs or image files to the company where some poor soul has to make sure this partial set of the original document is in fact complete. Then the money has to be sent by wire or bank draft. Presumably if half a planned offering has already been completed in this manner, and there is a surge of demand from retail investors which resulted in a 20% oversubscription, any company that made the "pro rata" provision would have to wire back 20% of the funds already received and force the investors to resubmit all their paperwork. Whom are they trying to kid? For the regulators to even talk about "pro rata" they have to be either really stupid or cynical chortlers. These pointless obstacles to efficient financing activity by retail investors make it difficult for crowd-funding sites such as Red Cloud to function as a match-maker between retail investors and companies. But that should not be surprising because it is hard to avoid the view that the regulators are regulating for the benefit of financial institutions who are not keen to see companies raise capital directly from individual investors via an intermediary which takes a fraction of the percentage demanded by the "gate-keepers". But that view is outdately mistaken, because the real agenda of the financial instutitions is to purge the system of individual venture capital listings so that they can robotically advise their captive audience into "risk appropriate" structured products without fearing leakage of capital into retail investor generated ideas. You cannot just declare a genocidal war on a Canadian institution such as the resource juniors without creating an uproar. It is much more effective to slowly starve public companies to death by inventing obstructive regulations in the name of investor protection. This is happening in Canada courtesy of harmless sounding concepts such as the "client relationship model" and "suitability", concepts anchored in empirical facts such as age, health and existing wealth rather than the will of the individual. The Americans are starting to call foul on this cynicism; when will Canadians stand up and call foul?


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