It's a test that's defined by law [1], ostensibly to protect the non-wealthy from being scammed easily. [2] AFAIK, the intent is to prevent scammers from directly selling highly risky investments to the average Joe without explaining to them the complete depths of the risk.
Yeah, well, it also fucks over an intelligent but average-income Joe from being allowed to invest in deals that have as high of a return.
For instance, I know right now that I'd like to invest a chunk of cash into several VR companies. I can't, though, because I'm not accredited. I have to wait for their IPOs, which will happen way after everyone already finds out how much it's all worth.
The good of accredited investor laws far outweigh the bad.
People who don't have a lot of money are much more likely to not have good money management skills than people who are able to hold on to lots of money for long time periods.
Without accredited investor laws you would just pour tons and tons of dumb money into the system and the volume of scams would go way up.
This is not to say there are not rich people being conned, but when that happens it often does not bankrupt them because they are less likely to go all in on a single asset. Something people with poor money management skills want to do all the time.
True scams aren't much slowed by accredited investor laws. Scammers just move into the areas - gambling, real estate, amateur high-frequency-trading, under-the-table offerings - that escape SEC control. And people with poor money-management skills can already put all their money into legal things that go to zero - like lottery tickets or leveraged real-estate or Enron or pre-reorganization GM.
And, 'dumb money' mainly gets smart by trial-and-error, and observing the lessons of peers. Locking all non-millionaires out of private investing prevents that process from even starting.
Clearly we shouldn't let middle class people fund budding enterprises.
It is better to forcefully stop rational people from risking their money, in an attempt to protect irrational people from making irrational decisions.
People who want to let the middle class take risks that could help them become wealthy are operating under the premise that this is supposed to be a free country---a premise that the country's elected and respected political leadership has wisely decided to adamantly ignore.
Leveraging your residence 95% or more to speculate in your local real-estate market is favored by tax policy.
Equity investing, day-trading, and option investing are all available to non-accredited investors.
In all of these activities, your principal can go to zero very quickly, and will if you're overconfident and misinformed. How is private investment any more irrational or dangerous? Can't 'poor' people sometimes have excellent, inside information on a new business, or are only already-wealthy people informed and rational?
In the case of the Bitcoin Investment Trust, the effect of the accreditation-barrier is even more pernicious and counterproductive. There's no block against the poor owning Bitcoins - they can buy them in many ways. There's just a block against those Bitcoins being professionally secured, and getting the tax-advantages available in IRAs.
How are poor, irrational people protected by making them self-secure their Bitcoins while paying higher taxes on any gains?
shrug It's been the law of the land for what, 80 years?
If you want every body and their brother to invest with minimal restrictions: you register the security and create all of the disclosures. If you don't want to go through the effort of creating prospectus and accurately describing the risk, and requiring lots of sign-off from the investor? You limit yourself to the wealthy.
Those things the equity investor, day-trader, and optioneer may invest in are all registered securities with all information required by law filed and up-to-date.
I'm not arguing that poor people are irrational (that's a straw-man, and nothing in the laws have ever stated that poor people are irrational), and I find it offensive that you jump to this sort of polarizing attack rather than making a more substantive argument, as if to paint me as a person who thinks all poor people are dumb.
Now, we ask ourselves, how did this come to be the law of the land? Because people were regularly not disclosing all aspects of their investments to investors, and people, both rational and irrational, were regularly losing money they wouldn't have invested had they been given complete information as was known to the promoter of that investment.
However, many investors (quite rightly) balked at the idea that they could only invest in full-registered securities, so some test was created - it happened to be a means test. What would you replace with as a test for securities that do not require complete and accurate disclosure (which is what pretty much every early stage investment is)?
We've seen what that looks like: more disclosure. [0]
Lots of awful laws were "the law of the land" for much longer.
Why would a tradeoff from 80 years ago be appropriate for today's wealthier, more informed era? And when the other competing ways that people can lose all their net worth (gambling, real-estate speculation, leveraged/optioned public-security speculation) are so much more available?
It's no longer serving a protective function... but that rationalization is still trotted out, out of habit and status-quo bias.
You implied irrationality among non-accredited investors, with your question, "how can you make a rational decision...?" Well, non-millionaires can be just as rational as millionaires, within these domains.
As a practical matter, firms can't just increase their disclosures and then accept investment from everyone. The costs and legal risks are too high - the regulations preclude non-millionaires from rationally accepting the same level of disclosure and disclaimers as millionaires are allowed. So less-wealthy people get locked out, by regulation-imposed costs.
The means-test is unjust discrimination, just like if a community said, "you may have the cash to pay the asking price for a house here, but we'll need to x-ray your personal finances to determine if you're really suitable for our community".
I would replace the means test with the same test required to buy a state lottery ticket: are you 18 and do you have the cash?
If compromise is required, I'd replace the means test with a means-oblivious competence-evaluation: do you understand the risks and instruments involved? Wealthy people – heirs, lottery winners, successful businesspeople – wouldn't get a free pass, they'd have to pass the same test. (That would help ensure that politically-influential wealthy people also lobby to keep the test from becoming too exclusionary.) Many kinds of certifications – like college degrees in business/economics/law or the standard tests that already exist to qualify people as a banker/lawyer/accountant/investment-adviser – should serve as adequate proof of competence. (For example, pass the 'Series 7' that allows you to recommend and manage investments for others, and we'll assume you can also invest for yourself.)
After all, who's more at risk from a shady private investment: a trustfunder 'accredited investor' or an MBA/CPA/licensed-investment-professional? Current law favors the trustfunder at the expense of the certified expert!
If even more compromise to paternalism is required, private-security investments could be subject to a proportion-of-net-worth test. For example, perhaps only 1/2 to 1/3 of net-worth could be placed in such securities. Or, only an amount that's less that that already saved in tax-advantaged retirement accounts (IRAs/501ks/etc).
Any of those standards make more sense than the "are you already rich?" test.
> Lots of awful laws were "the law of the land" for much longer.
I don't think it's as awful as you make it out to be. I think the situation before it was passed into law was far, far worse for the prosperity of individuals than it has ever been after. But, that's just, you know, my opinion.
> You implied irrationality among non-accredited investors, with your question, "how can you make a rational decision...?" Well, non-millionaires can be just as rational as millionaires, within these domains.
No, I didn't, as I assume you're familiar with securities law, I would presume that you could see that I was contrasting registered securities with required disclosures, and unregistered securities with little or no disclosure. Perhaps I should've phrased the question instead as "How can you make a good decision when the other party is intentionally hiding relevant information from you?"
> If compromise is required, I'd replace the means test with a means-oblivious competence-evaluation:
That sounds awfully complex to codify. Who gets to write the questions? What happens when the subject is not previously coded up into a test? Endless questions.
What this all really boils down, what I'm getting from this, is that you feel that you're smarter than the average bear, and you feel that the rules are holding you back from really succeeding, so let's make some rules that you'll pass. That's not intended as a personal insult, that's just how it comes across.
> If even more compromise to paternalism is required, private-security investments could be subject to a proportion-of-net-worth test. For example, perhaps only 1/2 to 1/3 of net-worth could be placed in such securities. Or, only an amount that's less that that already saved in tax-advantaged retirement accounts (IRAs/501ks/etc).
Actually, that makes a lot more sense than anything else you've come up with, and more akin to my reading of the reasoning behind the means test. It has nothing to do with any one individual, but instead to avoid massive culling of the fortunes of the middle class at once and causing social unrest. If its more difficult for the masses to invest primarily in high risk investments that more often fail than succeed, then they will likely invest in lower-risk, or at least more well codified risk, which is more likely to achieve a more stable economy and reduce the risk of public upheaval. We have a lot of history in the unregulated investment markets to draw from in painting a picture of the potential future. Your assumption that people have more information now, readily available to them about the quality of investments with little or no disclosure is one I'd call into question. People in the 'teens certainly felt they had a lot more information about the quality of investments with little or no disclosure than they did in the early 1800's.
But, we have a stark difference of opinion. I never felt that the accredited investor test was holding me back from succeeding and making good investments. In fact, I've never found a rule that was really holding me back from succeeding, but that's just me, I guess.
The "same rules apply to rich and poor" approach isn't complex to codify: it's the simplest. Just don't grant special privileges to people based on their net-worth.
Nor is a competence test complex: I already outlined a possible regime. Just reuse any college degree in a related field, or any existing related professional certification (CPA/Series7/Bar). More generally, simply saying that "whatever test applies to the rich, will also apply to the poor" will tend to work itself out. Regulators will figure out some protective test that the rich can tolerate, and that's good enough for the poor as well.
People are wealthier and more educated than ever before. More information about others' experiences is available at little cost. More people have incremental experience with similar instruments (such as public companies).
But most importantly, anyone who's stayed 'middle-class' has already resisted thousands of kinds of legal scams, some promoted by the government (like lotteries and home-ownership-at-all-costs) that could easily relieve them of all their money. "Massive culling of the fortunes of the middle class at once and causing social unrest" is a paranoid, fancifully unrealistic scenario. Some people would dabble in private-investing like they have with many other financially risky activities, and over time they'd either receive positive reinforcement for sustainable actions, or negative reinforcement for recklessness. Investing in the same sorts of deals as millionaires is not an unprecedented and magically addictive activity that the poor can't resist.
That is a false standard of rationality. Nobody has complete information, ever. Nobody is omniscient.
To restate my point without sarcasm:
If somebody genuinely wants to risk their money as an investor, it's not in their self-interest for us to forbid them to do so. That is what they want to do. And it's also not in anyone else's self-interest to forbid them from doing it. Investment and entrepreneurship is what drives the economy.
More abstractly: There is no valid chain of logic that starts at perceptual reality and ends in the conclusion that we should forbid people from investing as they please.
I'm not claiming that this exhausts the topic---there are objections you can raise, but I believe I would always be able to answer them. (I've dedicated much of my life to these kinds of philosophical issues and have achieved a rare level of clarity on them, but I recognize that from your point of view, this is just an arbitrary assertion.)
> If somebody genuinely to risk their money as an investor, it's not in their self-interest for us to forbid them to do so. That is what they want to do. And it's also not in anyone else's self-interest to forbid them from doing it. Investment and entrepreneurship is what drives the economy.
If schemes don't lie about what they are, aren't they similar in their payouts - some win, some lose - to legally-sanctioned (and in some case, state-run) gambling?
The potential crime would be fraud - pretending a ponzi is a non-ponzi. With accurate disclosure, it's just an odd form of gambling where some late-entrants are still paying in, when there's no more chance to win.
Like the other guy said, I am against fraud. If there is no fraud (intentional deception), a Ponzi scheme should be legal, but 99.9% of times, a Ponzi scheme involves fraud.
When you engage in trade with someone, you are implicitly or explicitly authorizing them to come after you with the force of the law if you have intentionally deceived them.
Note that the government isn't, anyway, necessarily capable of policing Ponzi schemes, because it's not omniscient. Madoff was regulated by the SEC, which gave some of his investors false confidence.
Prior to the securities Act of 1933, the measure of viability of a particular investment vehicle was on a state-by-state basis where they wouldn't allow investment vehicles that were unlikely to return a positive return to most investors (see Blue Sky Laws). The Act required all securities to be traded to be registered (in a nutshell), but allowed a loophole that effectively said "if the investor can afford to lose all of their investment, you don't need to go through the trouble of registering it, and you can rely on the investor to judge the value of the investment."
Who am I? I have no intent to judge, however, as the act was prompted not by fantasy, but by watching many, many investors get sold on bad deals via poor information. In fact, the event which led to this was considered one of the greatest financial disasters in the history of America.
So, you may be smart - and you may in fact be smarter than all of the swindlers who may try to take your money. I'd wager most who don't invest as a primary exercise aren't that smart (I only need to look back a couple of years), and I can't imagine how you'd propose to change a -means- test with an -abilities- test. Before you can invest in an oil well, should you be required to prove that you are above average in knowledge about the business of running oil wells?
I doubt simply "finding out" would guarantee enforcement. They'd need time and an inclination to care, and tangible evidence. If there was no crime by the issuer other than being a little too trustworthy, it's unclear what the prioritization and penalties would be.
I suspect the bigger risk is that the buyer – the not-really-'accredited' – has some dispute with the company and sues, causing problems because the various assumptions-of-competence (that come with 'accredited' status) are then voided. It gives a bad-faith or disgruntled investor more leverage over the issuer.
Has any individual ever been charged with fraud for misrepresenting their wealth? I understand its likely that the company faces fines and such, but I've never heard of an individual getting in trouble.
Well, the company could certainly be in hot water for selling to a non-accredited investor, but I've yet to see anyone who can point to a penalty that can be levied against the lying investor.
Wealth tests ought to be just as illegal as other forms of discrimination.