Leveling The Investment Playing Field: A Call for Change In Accreditation Rules

By Joe Endoso, Chief Operating Officer, Linqto

One of the greatest inequities in the United States today is investing. It's one thing to recognize that someone with a million dollars invested in public equities will grow their wealth faster than an individual with $100,000 invested in the same companies. But consider this: the million-dollar investor has access to higher returns than their counterpart. I'm not talking about the modest 10% annually returned by the S&P. They have access to an entire investment class—alternatives—which the smaller investor does not. To invest meaningfully in alternatives, one must be an accredited investor. Fortunately, a new proposal in Congress is looking to make it easier to become an accredited investor to level the investing playing field.

To illustrate the current law's unfairness, a Cambridge Associates report compared the returns of 2,332 venture capital funds, one form of alternative investment, to an adjusted public index over a 25-year period. The venture capital funds averaged 25% annualized returns, while the NASDAQ composite returned just under 10%.

Regrettably, the current guidelines for accredited investor status are "asinine," as Brandon Brooks, Partner at Overlooked Ventures, told Congress on April 24th. To qualify, an individual must have a net worth over $1 million (excluding their primary residence), a personal income of $200,000 ($300,000 with a spouse) in the past two years, or hold a FINRA Series 7, 65, or 82 license. 

The first problem is obvious: wealth doesn't guarantee good investing decisions. Former NFL quarterback Michael Vick filed for Chapter 11 bankruptcy after failing to repay $6 million in loans used for business investments. Fashion executive Carola Jain lost millions after providing a loan to Billy McFarland for the infamous FYRE Festival.

While many wealthy people are smart investors, assuming wealth equates to smart investment decisions is not always accurate. The SEC recently expanded the definition of accredited investors to include licensed investment professionals. Ironically, many professionals leading institutional investments into alternatives are unable to invest in such alternatives outside of their own fund of employment. For example, a junior associate at a venture capital fund who regularly conducts due diligence can’t invest in a company seeking a VC investment outside of his firm. Conversely, a Series 7 license holder who advises local public servants primarily allocates to public equities and fixed-income securities and has no experience with alternative investments. However, they can make investments in any VC-backed company as they qualify as an accredited investor.

The accreditation system in the United States is outdated and in dire need of change. Fortunately, the House of Representatives recently proposed a change. On April 24th, 2023, Representative Mike Flood introduced "H.R. 2797 – Equal Opportunity for All Investors Act of 2023" with bipartisan support. The bill proposes amending accreditation rules by allowing an SEC-administered test, enabling anyone demonstrating a certain level of proficiency to qualify as an "accredited investor."

Though the bill is in its infancy, a knowledge-based accreditation system offers numerous benefits. Knowledgeable investors can build larger, more diversified portfolios exposed to higher-returning asset classes. Venture capital and private equity funds can create "retail allocations," allowing retail investors to invest in these funds managed by professionals. Lastly, the proposal could benefit companies raising capital by enabling customer investment, increasing public interest in the company and its products.

For instance, drone delivery company Zipline gained attention when YouTuber Mark Rober profiled their technology in a video with over 19 million views. Many viewers expressed investment interest but were unable to do so due to current accreditation limitations and the fact that companies like Zipline can't remain private if they have thousands of small retail shareholders.

In conclusion, it's time to overhaul the outdated accreditation system in the United States. Embracing a knowledge-based accreditation system will level the investment playing field and foster a more equitable future for all parties involved. The Equal Opportunity for All Investors Act is a crucial step towards achieving this goal, and its passage would undoubtedly have a positive impact on the investment community.

By providing more individuals with access to alternative investments such as private equity and venture capital, we can break down the barriers that have long favored the wealthy few. This change will not only empower savvy investors, but also help drive innovation and growth for companies seeking capital. Furthermore, the diversification of investment opportunities could lead to greater financial stability and wealth generation for a broader range of people.

As we move forward, it's essential that we continue to push for reform in the investment world, ensuring that everyone has a fair shot at building a secure financial future. The Equal Opportunity for All Investors Act represents a significant stride in the right direction, and its success will mark a milestone for equity and inclusion in the United States investment landscape.