Bill mandating SEC test for accredited investors draws criticism

Legislation by Rep. Patrick McHenry, R-N.C., would allow anyone who passes the agency's exam to purchase unregistered securities, but credentialing groups are concerned about the mechanism for becoming a sophisticated investor.

New legislation would allow anyone who demonstrates a high level of financial acumen to invest in private offerings. But some groups that sponsor investing credentials are concerned the measure’s mechanism for becoming a sophisticated investor is flawed.

Earlier this week, Rep. Patrick McHenry, R-N.C., introduced a bill that directs the Securities and Exchange Commission to develop a qualifying examination to be an accredited investor.

McHenry, the ranking Republican on the House Financial Services Committee, sees the exam as a way to expand the pool of investors who can buy stock in start-up companies and other unregistered securities. Currently, those ranks are mostly limited to people who meet certain net worth and income thresholds.

“The accredited investor regime keeps everyday Americans on the sidelines,” McHenry said in a statement. “My bill will allow more investors to qualify as ‘accredited investors,’ providing them with more opportunities to invest their money the way they want.”

John Bowman, senior managing director at the Chartered Alternative Investment Analyst Association, said he agrees that education and sophistication should be the gateway to private markets, not simply wealth.

But he said the exam should be developed by industry and professional groups rather than the SEC, which should act as a clearinghouse.

“Republicans want nobody to fail this exam. Democrats want nobody to pass the exam,” Bowman said. “As a result, we need an objective third party to develop an examination that ensures investors are protected.”

It’s not clear that expanding the accredited investor definition is necessary given the proliferation of investment products that provide retail investors with access to most asset classes, including private securities, said Kurt Schacht, managing director for policy advocacy at the CFA Institute. The organization sponsors the chartered financial analyst credential.

“Speaking from an organization that knows a thing or two about testing and training for financial industry proficiency, it is not a simple thing for the SEC or anyone to put together a simple test that will reliably determine investor sophistication and acumen,” Schacht wrote in an email. “Maybe it’s worth a try, but with all the new investment products available to retail for private market exposure, we might not need that.”

Last fall, the SEC approved a rule that would expand the accreditor investor definition to include people who have professional certifications — such as the Series 7, Series 65 or Series 82 securities licenses — or other kinds of specialized work experience and background.

“The [McHenry] bill builds on the rulemaking the SEC has already completed,” said Anya Coverman, senior vice president for government affairs at the Institute for Portfolio Alternatives.

She’s confident the SEC can develop an examination that determines who has the financial skills and knowledge to navigate private markets.

“The SEC has the experience in how to appropriately manage and deliver the test,” Coverman said.

An SEC with a Republican majority led by former Chairman Jay Clayton, who had a strong interest in opening private markets to ordinary investors, approved the expansion of the accredited investor pool.

The current Democratic-majority SEC has indicated on its regulatory agenda that it will seek public comment on further updating the commission’s rules on private offerings, which could mean revisiting accredited investor reform.

Republicans are in the minority on the House Financial Services Committee, which makes it unlikely McHenry’s bill will get a hearing. But the legislation sends a message about how Republicans would approach private market reform if they take over the House in next year’s elections.

Coverman pointed out that previous accredited investor legislation to reform the accredited investor “has had bipartisan support.”

Even though McHenry’s legislation likely won’t make progress in the near future, it’s catalyzing an important debate on financial sophistication, Bowman said. “What McHenry has done is initiate a well-intentioned dialogue around expanding the definition and creating more avenues to become accredited.”