Democratizing Startups Requires Financial Freedom
On August 26, 2020, the SEC made modest and insufficient changes to the accredited investor definition which include professionals holding FINRA Series 7, 65, and 82 licenses. These are expensive, time consuming, and unduly burdensome financial literacy / sophistication tests reminiscent of voter literacy tests that kept Americans from exercising their civic freedoms.
The majority of Commissioners agree that more needs to be done to increase financial freedom. However, little is said about the harm that the current rule done. The SEC’s part in perpetuating discriminatory finance practices contribute to the loss of an estimated 9 million jobs and $300 billion in collective national income.
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Here is what the Commissioners and the SEC's Small Business Capital Formation Advisory Committee have to say.
SEC Small Business Capital Formation Advisory Committee Meeting
On August 4, 2020, the Small Business Capital Formation Advisory Committee met specifically to focus on How Capital Markets Are Serving Underrepresented Founders. On August 26th, the Committee published a general recommendation acknowledging a need for leadership to close the startup funding gap.
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Accredited Investor Rule Ignores Public Markets
The SEC’s mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” Yet the current definition of “accredited investor” defies all three of these mandates. The opinion of SEC Commissioners seeking to further reduce the number of accredited investors states "The accredited investor definition is the single most important investor protection in the private market.[1]" This is a misnomer. The definition is not a protection, but a restriction - one that applies only to the private markets.
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Data from Cambridge Associates and Capital Dynamics show that “private equity investments offer greater protection against financial downturns than public equity indices.” Restricting access to less volatile, high risk, high return investment options based on 3rd party accreditation is unfair. Moreover, it impedes the development of efficient private markets, which ultimately feed the public market, even as new, innovative, secondary markets emerge.
The greatest inefficiency exists in the lack of opportunities for underrepresented founders and investors to improve their positions through calculated risk, and the ability to seize opportunities without expensive, time consuming, and overly-complicated professional designations such as the Series 7, 65, and 82 designations.
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Remember 2008's Stock Market Crash?
The greatest risks to Main Street, "retail" investors, public interest, and the economy, exists in the public markets. In fact, the SEC was formed in response to the 1929 Stock Market Crash to protect retail investors from institutional bad actors and insider trading - an area of oversight at a three-decade low. Documentary films like The China Hustle, and Chasing Madoff underscore how senior citizens and others have been demonstrably harmed, with entire nest eggs / 401Ks at risk Furthermore, the public market requires far more sophistication with its complex investment strategies (calls, puts, spreads, etc.) and consumer apps allowing retail investors to invest beyond their means through the use of margin.
The most important investor protection, free investor education on how private market investments work, is more abundant than ever. The SEC can do better to leverage these resources to increase investor education on private investing instead of pandering to lobbyists like NASAA who profit from Advisor licensing and oversight. Education will increase investor sophistication and decrease the likelihood of private market fraud. Furthermore, it will increase confidence in the markets, facilitate more efficient capital formation, and wealth creation, all of which will lead to increased participation in the public markets through advised funds.
The spirit of investor protection is disclosure. Disclosure expectations for newly formed companies should not be expected to mirror publicly traded companies with significantly more robust operations. The most pertinent disclosures for private companies, are the business model, team, capital and liquidity risks.
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