Matt Tramel, the IPA’s chief communications officer, recently sat down with Greg Mesack, partner at the Eris Group, and Anya Coverman, senior vice president, government affairs and general counsel at the IPA, to discuss the latest legislative and regulatory updates surrounding direct participation programs. The discussion highlights the important role of the IPA’s policy advocacy initiatives in strengthening the capital markets for DPPs.
Let’s first talk about expanding the definition of an accredited investor, which the IPA has long supported. Could you describe the IPA’s advocacy on this important issue? What have we done up until now, and what does it look like going forward?
Greg Mesack
From a policy perspective, the IPA has been very active on the definition of “accredited investor” starting back in 2014, when the SEC, per the Dodd-Frank Act, was required to report on the definition of an accredited investor. The IPA became concerned that future SEC rules could dramatically shrink the pool of accredited investors, drying up a significant source of capital that is being used for positive economic activity — investing in commercial real estate, for example. We began actively engaging the SEC, including meeting with their staff and commissioners, to explain that we should look for prudent, responsible ways to grow the pool of accredited investors. Even though some investors may not meet the financial-based thresholds, they could have professional experience or educational background that should be considered.
Simultaneously, we worked with Congress for the past three years on legislation — in both the House and the Senate — and, specifically, we engaged the committees with jurisdiction over the bills. Now we’re seeing real progress, with bipartisan legislation having passed the House and introduced in the Senate. We’ve educated policymakers and regulators, which has had a positive impact. We believe the legislation is moving in the right direction and that the SEC is also looking at the issue from a similar perspective as the IPA.
Anya Coverman
By way of background, the current definition of accredited investor was established in 1982 as part of Regulation D and provided that a person would qualify if they had an individual net worth — or joint net worth with a spouse — that exceeded $1 million at the time of purchase. Today the definition excludes the value of your primary residence in calculating net worth. An investor can also qualify if he or she has had income exceeding $200,000 in each of the two most recent years, or their joint income with a spouse was $300,000 for those years, with a reasonable expectation of the same income in the current year. The Dodd-Frank Act requires the SEC to review the definition as it relates to natural persons every four years. While the SEC issued a staff study in late 2015 considering potential changes, the definition has not been comprehensively reviewed or updated since 1982. Meanwhile, the accredited investor definition is the cornerstone of Regulation D, which provides the most widely used exemptions from registration for issuers of securities offerings. As such, it is a vital capital raising tool for many businesses in today’s market. Unfortunately, because the definition does not take into account nonfinancial thresholds, such as education, professional or investment experience, or licensing credentials, many individual investors do not qualify and are unable to participate in investment opportunities available to other high-net-worth or institutional investors. The IPA has been actively engaged in supporting the House and Senate accredited investor bills that expand the definition in a responsible and prudent manner, and we continue to encourage the SEC to do the same. We are hopeful that this commonsense bill, which has bipartisan support in both the House and Senate, and which passed the House with overwhelming support, will make it to the President’s desk.
As you both discussed, the IPA is supporting both the House and Senate versions of the Fair Investment Opportunities for Professional Experts Act. What would passage mean for our industry?
Greg Mesack
It does three things that are beneficial for IPA’s members. It codifies by statute the numeric thresholds for income and net worth, and adjusts for inflation only on a going-forward basis. It also allows individuals with sufficient educational background or industry experience, who might not otherwise meet the financial-based thresholds, to still be defined as accredited investors. These individuals should have the opportunity to make investments because they have the requisite financial knowledge and clearly understand the risks of an investment. We should be expanding investors’ opportunities to diversify their portfolios and grow their wealth outside of the traditional equities markets. And finally, for those who don’t meet either the financial thresholds or have the requisite professional credentials, it establishes a financial literacy test to demonstrate their investment sophistication. All three of these are common sense.
Anya Coverman
In addition to codifying the current financial thresholds into statute, the bills recognize that certain investors should qualify as accredited based on nonfinancial, or qualitative, factors. In other words, individuals can be deemed accredited if they have a sufficient level of financial understanding and expertise, and the ability to withstand the risk of loss. These were the core tenants of the accredited investor definition when it was originally created. The bill also includes persons that have passed examinations that test their knowledge and understanding in the areas of securities and investing, including the Series 7 or Series 65. For our members and our industry, this means that the pool of accredited investors will be expanded, but in a responsible manner. It will also mean that the SEC will be charged, along with FINRA, with setting forth a new process — whether by test, certification or other qualification — by which these additional investors will qualify under the definition. While the IPA strongly supports this bill, we have also noted that it should include the reasonable belief standard currently found in Regulation D, and a grandfathering provision to allow existing investors to participate in future investments in the same issuer to avoid dilution of their current investments.
Regulation A+ expansion has been an advocacy priority for the IPA and was recently passed into law through the Economic Growth, Regulatory Relief and Consumer Protection Act. How did that bill achieve such wide-ranging, bipartisan support?
Anya Coverman
To be clear, there are two separate Regulation A+ bills that the IPA supports. The Regulation A+ bill that was part of the Economic Growth, Regulatory Relief and Consumer Protection Act, which passed in late May, allows SEC reporting companies — those that file annual, periodic and other reports under the Securities Exchange Act — to qualify for the Regulation A+ securities exemption. Previously, only nonreporting companies could take advantage of Regulation A+. While most IPA members are already able to raise money under Regulation A+ — or through a public nonlisted program — this was a common-sense bill that expanded the opportunities under Regulation A for reporting companies. This is significant for issuers that are subject to the Exchange Act and whose securities may trade on over-the-counter markets, as compared to larger exchange-traded issuers that can use the Form S-3 for quick access to capital. The other Regulation A+ bill that the IPA supports is the bipartisan Regulation A+ Improvement Act, which passed the House in March. This bill would increase the Regulation A+ Tier 2 threshold from $50 million to $75 million — again a reasonable and common-sense measure. In fact, the IPA believes that with some additional investor protections, that threshold could be further increased to $100 million or more. We hope this bill will gain traction in the Senate, and we will continue our support for it in both chambers.
Greg Mesack
The Regulation A+ bill that was part of the Economic Growth Act passed in the old-fashioned way: a lot of work and a lot of discussion! There is a desire between both parties on Capitol Hill to try to help small financial institutions and investors invest more capital into the economy. Senators on both sides of the aisle came together and asked, “What can we put together that we all agree on?” They started cobbling together the issues that are important to all of their constituents and came up with a bill that was bipartisan and helps a broad array of financial institutions and investors. It took a lot of leadership from both sides of the aisle, and they got it done.
Explain why the IPA is focused on these capital market issues in terms of growth and efficiency in our own industry.
Greg Mesack
We are trying to find more ways for IPA members to offer a wider array of high-quality investments to diversify people’s portfolios. When companies have more flexibility, they can provide more products to their customers to help them achieve their investment goals. And when investors have more products to choose from, more capital will flow into the economy. That is the proverbial win-win.
Anya Coverman
The IPA will continue to support and push for capital formation measures that give investors more opportunities and options, stimulate the economy and support job creation. We also believe in high-quality, transparent products. Our members are uniquely positioned to support these initiatives because they provide these types of long-term investment products, many of which are state- and SEC-registered, thus providing a great deal of disclosure and transparency. This aligns with Congress’ goals — to create fair and efficient markets and investment opportunities not only for institutional investors, but also for the average mom-and-pop investor.
Moving on to the Small Business Audit Correction Act of 2018, why did the IPA support the bill, and what effect would it have on raising capital in our industry?
Greg Mesack
This bill is a perfect example of common-sense legislation that removes unnecessary burdens. The Public Company Accounting Oversight Board (PCAOB) was created out of the Sarbanes-Oxley Act in 2002 to provide oversight of public company auditors. Eventually all brokers-dealers would be required to have their audits completed by a PCAOB-registered auditor. But what they didn’t realize is that, for a small broker-dealer with only a few reps, or that doesn’t have custody of the actual assets, that is overly burdensome from a time and financial resources perspective. This bill says that if you are noncustodial or you have 150 reps or less, and you are not public, you can go to any auditor that works best for your business. So while this law isn’t targeted to capital formation, it will remove unnecessary regulatory burdens. The IPA is trying to make their members’ lives a little bit smoother and easier.
Anya Coverman
The IPA conducted a survey of its members and found that it is very difficult for small broker-dealer firms to find a PCAOB-registered auditor to conduct small firm audits. Few conduct these audits and increasingly charge high fees, as it is not cost effective for them from a profit standpoint. Moreover, the paperwork required is tailored not to small firms but to large public companies or brokers that carry customer funds or securities. There is a lot of support for the bill, including from industry coalitions. In fact, the FINRA Small Firm Advisory Committee and its three small firm representatives on the FINRA Board of Governors are also working separately with members of Congress, the SEC and the PCAOB to gain this small firm exclusion from the requirements. This is another bipartisan effort supported by many different participants.
The growth in Direct Participation Programs continues, given how popular they are with advisers and the important investment solutions they offer. What does the future regulatory environment look like from the state securities perspective, and is there anything on the front burner in relation to DPPs?
Anya Coverman
The states continue to review nontraded, registered investment products, including nontraded REITs and business development companies. From a private placement perspective, states do not review or regulate federally covered securities offerings such as Regulation D (i.e., Rule 506) private placements. States continue to have an important role in policing markets for fraud and bad actors, which is work that the IPA fully supports. The IPA believes that protecting investors and giving them confidence to invest in the market and diversify their portfolio is the best way to increase access to capital. Working alongside federal and state regulators supports the growth of our industry, and so we view the role of the states as going hand-in-hand with the mission of the IPA.
Greg Mesack
The states are trying to protect the investors in their states from fraud. What the IPA has also been doing for years is continuing to educate state regulators about our products and about the value they provide, given that some of them are not as well known. Some state regulators may have preconceived notions about some DPP products, and it is our job to continue to explain their value in the market. We want to make sure that everyone can benefit from the important products that IPA’s members provide.
