The Securities and Exchange
Commission is drawing up plans to increase the number of people allowed to buy
stakes in hot Silicon Valley startups and other private companies. But that
population has already grown 10-fold since the 1980s, a Wall Street Journal
More than 16 million U.S.
households—about one in eight—are already allowed to invest directly in private
companies, according to the analysis. Private companies don’t have to make the
disclosures that public companies do, and regulators thus limit them to only
relatively wealthy investors. When the SEC first set its rules of entry for
private markets in 1982, only 1.5 million households made the cut.
The reason more households are
eligible: The SEC uses income and net worth to determine who can invest, and
the thresholds haven’t changed in more than three decades.
As private markets boom and the
number of public companies shrinks, SEC Chairman Jay Clayton says he now wants
to give even more investors the opportunities to buy into fast-growing private
companies, such as Uber Technologies Inc. and Airbnb Inc. Further opening
access to these markets could ultimately reshape the financial landscape,
allowing millions of retail investors to add startups to traded stocks and
bonds in their portfolios.
But such investing can be
high-risk and more opaque than the public stock market—and a draw for
fraudsters. Tens of billions of dollars a year of private stakes in companies
are now being sold by securities firms with an unusually high number of brokers
with three or more investor complaints or other red flags on their records, a
recent analysis by the Journal found.
“The biggest area of fraud has
always been in these private offerings,” said Denise Voigt Crawford, a former
Texas securities regulator. “Now you’ve got more people that are eligible to be
the victims of fraud.”
An investor typically has to be
“accredited” to buy stakes in private companies, which requires an annual
income of more than $200,000 or a net worth of more than $1 million—a rule
designed to ensure that anyone allowed into these markets can afford to lose
what they put in.
The SEC hasn’t increased the
accredited-investor limits since they were set, apart from a 2012 tweak that
excluded primary homes from the calculation of net worth. If the limits had
been adjusted to keep pace with inflation, an accredited investor would now
need an annual income of about $515,000—more than double the actual $200,000
limit—and a net worth of more than $2.5 million, the Journal found.
Sales of these investments, known
as private placements, are expanding rapidly as investors chase profits outside
more traditional stocks and bonds. Last year, a record $710 billion was sold
through brokers, a nearly threefold rise from 2009, the Journal reported. For
this year through August, at least $500 billion has been sold through brokers.
The SEC is expected to seek
public comment in coming months on expanding the accredited-investor
definition. It is unclear how many more investors would become eligible for the
market under the SEC’s plan. One addition Mr. Clayton talked about recently is
people who don’t hit the financial limits but have professional licenses or
Further opening access to private
markets could let millions of retail investors add hot startups such as Uber
Technologies to their portfolios. An Uber logo is seen on a car’s windshield.
John Harrison, executive director
of the Alternative and Direct Investment Securities Association, embraced the
SEC idea, saying sophisticated investors “should be allowed that opportunity”
and are an essential source of capital for growing the economy.
But Barbara Roper, director of
investor protection at the Consumer Federation of America, said the current
accredited-investor limits “aren’t even remotely adequate to ensure people are
protected from potentially devastating losses.”
An SEC spokeswoman declined to
Complaints from investors have
grown in recent years with the swirl in sales. Arbitration claims relating to
two kinds of private markets’ investment, private equities and limited
partnerships, ballooned from 192 in 2013 to 294 last year, a 53% five-year jump,
according to the Financial Industry Regulatory Authority, which oversees the
Some brokers target people
approaching retirement, whose salary or pension savings push them over the
accredited-investor thresholds, according to lawyers representing investors. A
third of the accredited households are retirees, the Journal’s analysis found.
Roy Manson, a former health-care
executive in Scottsdale, Ariz., said he wanted a low-risk investment strategy
after he retired in 2011. But his Center Valley, Pa., broker, Robert D’Agosta
of Berthel Fisher & Co. Financial Services Inc., persuaded him to invest
what Mr. Manson said was the “lion’s share” of his savings in private
placements and other high-risk investments, some of which fell sharply in
value. “These sales earned the broker high commissions,” said lawyer
Christopher Lonn, who is representing Mr. Manson in an arbitration claim due to
be heard next month.
“I’ve had so many sleepless
nights,” said Mr. Manson.
Mr. D’Agosta and a spokeswoman
for Berthel Fisher both declined to comment.
Some regulators and others wonder
if financial limits are the best way to decide who has access to private
“Being an accredited investor
does not today make you wealthy, and it absolutely does not make you
sophisticated,” said Douglas Schulz, a former investment adviser who testifies
in arbitrations for investors.
Kris Dielman, a former San Diego
Chargers guard, and his wife Sandy, for instance, are “entirely unsophisticated
financially” and leaned exclusively on their broker, Indiana-based Robert
Hoffman, who worked for Woodbury Financial Services Inc., according to an
arbitration claim filed by the couple against Mr. Hoffman and Woodbury that was
reviewed by the Journal.
In the claim, the broker
allegedly told Mr. Dielman that a $450,000 investment in 2007 in a now-defunct
company building blimp-like aircraft would increase his net worth by “2m (on
paper).” The following year, Mr. Hoffman sold Mr. Dielman a $150,000 stake in a
military building in Indiana, writing in an email, according to the claim, “we
will ride this thing like a cheap hooker!”
Mr. Hoffman, who Finra barred
from the securities industry last year, declined to comment. He agreed to be
barred for failing to cooperate with a Finra investigation, without admitting
or denying the regulator’s findings.
A representative of Advisor Group
Inc., which owns Woodbury, didn’t respond to requests for comment.
An arbitration panel in June awarded
the Dielmans $1.1 million in their claim against Woodbury. Mr. Dielman told the
Journal that “this whole thing was bullshit: The guy sleazed me.”
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