A Balanced Perspective on Accredited Investing

The Securities and Exchange Commission defines an accredited investor as an entity (individual or enterprise) who A) has had an annual income of $200,000 or a combined income of $300,000 for the past two years, or B) has a net worth (or combined net worth) of $1 million, or C) is a general partner or executive officer on behalf of the enterprise of the security being issued.

I became aware of the accredited investor stipulation at the end Jelurida’s Ignis / Ardor whitepaper. To my dismay, US citizens are not allowed to participate. Why!? I angrily shouted to the four walls of my studio apartment. Because the SEC has issued a few rulings recently, one of which is rather vague stating that some cryptos are securities* and because of this, the enterprise offering it must be registered with the SEC to sell to US citizens. In response some blockchain startups have simply barred US citizens from participating to avoid the legal red tape.

My basic position on accredited investing is that it’s an exclusionary policy, hurting small investors, however, there’s more nuance. After my initial anger, I stepped back to analyze both perspectives and avoid tribalistic / polarized thinking. In case you’re not from the US, polarization is off the charts at the moment. EG: The 2016 election and the two completely separate realities in which Republicans and Democrats are living.

The accredited investor clause is a form of rent-seeking. Rent-seeking* is defined as the act of manipulating public / economic policy to increase share of wealth without creating new wealth. How does excluding most of the population increase share of wealth? It bars average citizens from participating, allowing those already wealthy to gain more share of wealth. But how does this benefit the issuer of the security? It hurts their top-line profit — their revenue. Less investors means that there is less money flowing in. However, securities that are only offered to “accredited investors” are more loosely regulated and create less liability for the issuer. Although the top-line is hurt, the decreased liability makes up for it in the bottom-line.

Before we get our pitchforks out, I’d like to point out that the SEC is not made up of soulless monsters devoid of humanity. The Securities Act of 1933*, section D laid out the investing designation and was a direct response to the 1929 stock market crash which lead to the Great Depression — the worst period in American economic history, shadowed by the Great Recession of 2008. Accredited investor regulations were put in place to protect the little guy, but as always, the devil is in the details.

The philosophy behind this idea was noble, albeit naive — the stock market crash was complex, but its root comes down to unsustainable economic practices. The logic was that implementing the law would only allow educated investors to purchase stake in these high-risk securities, meaning the relative risk will be lower (because of their education). These investors are also wealthier will be more able to weather a significant loss. It was put in place so average people would not be taken advantage of by snake-oil salesmen.

This isn’t sound logic. It was the response of a panicked Congress under pressure from a panicked public. The accredited investor clause has been manipulated from a well-meaning mid-Depression piece of legislation meant to curb unhealthy economics, into a rent-seeking exclusionary economic policy.

Once other facets of society are examined, the logic very quickly falls apart. Ordinary people are allowed to take all sorts of risks both financial and health related. Casino's are legal in some areas, in fact, I'm from Atlantic City, NJ. People gamble their lives away and the economic impact has had real consequences, but it is still legal. Lotteries are portrayed as good for the public, because they fund various public projects, but they also deprive money to those who need it most based on false hope. The odds of winning the lottery are about as good as... well, your odds of winning the lottery. Drinking is legal, smoking is legal, and fossil fuels that pollute the environment and are driving us toward the sixth mass extinction are legal, but they are also very risky. Upon this closer examination, it is clear that the risk to ordinary people and those around them cannot be the real reason behind accredited investing laws.

The legislative system is always struggling to keep up with booms in technology. The decentralized nature of blockchain is throwing the still nationalized 20th century governments for a loop. Due to increased interconnectivity, physical borders are rapidly decreasing in importance, but legislation is slow to catch up. But what about globalization?

The United States has largely been the driver and chief beneficiary of globalization, but only for the architects of society driving the change itself. “Trade agreements” like NAFTA* have largely benefited the rich both in Mexico and the US, while the poor in both countries have been hurt badly. As the former head of the Fed Alan Greenspan* once said in testimony to Congress in 1997

“… Atypical restraint on compensation increases has been evident for a few years now, and appears to be mainly the consequence of greater worker insecurity. The willingness of workers in recent years to trade off smaller increases in wages for greater job security seems to be reasonably well documented. The unanswered question is why this insecurity persisted even as the labor market, by all objective measures, tightened considerably."

Noam Chomsky has famously reworded* this statement to “if the workers are more insecure, that's very healthy for the society, because if workers are insecure they won't ask for wages, they won't go on strike, they won't call for benefits; they'll serve the masters gladly and passively. And that's optimal for corporations.” Clearly Chomsky and Greenspan have views at the opposite end of the spectrum, but it is clear that Alan Greenspan was suggesting that worker insecurity was in part responsible for the US economy’s health and that it was a good thing. Worker insecurity was accelerated by NAFTA by shipping manufacturing jobs to Mexico.

Globalization is only meant to benefit a select few members of society — those Adam Smith would dub “the masters of society.”* However, blockchain technology allows the common citizen to subvert the opulent through a borderless payment system and decentralized applications (dApps). Because of this, the opulent have attempted beating this technology back. Notice that only in recent months have major publications and financial firms begun reporting on crypto, acknowledging it as a force that’s here to stay. Before this year, there was constant criticism that crypto’s doom was lurking around every corner. Eventually, the SEC’s stance on investments and securities will have to adapt to blockchain. The rise of the initial coin offering (ICO) is challenging traditional methods of raising funds — a sort of franken-crowdfunding. A weird cross between crowdfunding and securities investments.

While much of the regulation in this field is exclusionary, some regulation is a good thing. To reuse Adam Smith, the father of laissez-faire economics — even he believed there were times when a governing body needed to intervene in the economy. We’re in the wild-west phase of ICOs and blockchain startups. These companies raise millions of dollars in minutes, some of them without a strong foundational plan. Filecoin* just had a pre-ICO round of seed funding, raising $52 million — without even a minimum viable product (MVP). This seed round was only opened to a hand-picked group of accredited investors so as to play by the SEC’s rules. However, all they have is a whitepaper. This is fairly common in the blockchain world and many people have been taken advantage of and lost lots of money. Crypto needs some regulation.

However, that regulation doesn’t need to come from the SEC itself. Blockchain technology is built upon a trustless ledger wherein computers solve increasingly complex math problems and are rewarded for it. The keyword is trustless.There have been numerous improvements to blockchain technology since its 2009 genesis, including SegWit and sidechaining. It seems reasonable to think that this community could generate some sort of technology that would self-regulate the market.

To recap, while the accredited investor clause was meant as a protection for the little guy in response to the Great Depression, it has been contorted into a rent-seeking policy which ultimately hurts the little guy by excluding him or her from getting in on the ground floor of a burgeoning industry. However, because of the wild-west crypto environment, some regulation is needed as a protection against predatory companies looking to take advantage.

I’m sure there are those reading thinking “It’s their own fault. If you get screwed, that’s on you” Maybe you’re right. If you haven’t fully researched something and don’t completely understand it, you shouldn’t be pumping any serious money into it. If you can’t weather a 20% loss, then you shouldn’t be investing at all. Although, I would also say that society is a complex interwoven tapestry and adverse events ripple outward, not just hurting the individual(s) responsible, but ruining more lives in its wake. Take the housing crisis of 2008. That was a complex web involving a lot of people doing things they shouldn’t have. Predatory lenders offering mortgages that they knew weren’t affordable, crediting agencies overrating mortgage assets, individual homeowners taking out loans they couldn’t afford. All of these bad practices coalesced in a perfect storm damaging lives that weren’t responsible. Look at Greece. Look at the bottom 50% of Americans. We’re all worse off when unethical behavior persists unchecked. The market doesn’t always sort itself out before lives are ruined.

What’s a crypto-investor to do? I will keep investing in whatever projects I deem fit, regardless of the regulations in place, because I put in my due diligence. And if enough people also engage in this way, the SEC will be powerless to rent-seek.