Securities Industry Commentator by Bill Singer Esq

SEC Evaluates Possibility of Granting Relief During Catastrophic Hurricane Laura (BrokeAndBroker.com Blog)

SEC Halts Fraudulent Offering by Florida Investment Adviser (SEC Release)

SEC Charges BorgWarner for Materially Misstating its Financial Statements (SEC Release)

SEC Modernizes the Accredited Investor Definition (SEC Release)

Statement on Modernization of the Accredited Investor Definition (SEC Chair Jay Clayton)

Joint Statement on the Failure to Modernize the Accredited Investor Definition (SEC Commissioners Allison Herren Lee and Caroline Crenshaw)

Statement on Amendments to the Accredited Investor Definition: An Important Step Forward (Commissioner Elad L. Roisman)

Statement on Amending the "Accredited Investor" Definition (SEC Commissioner Hester M. Peirce)

SEC Adopts Rule Amendments to Modernize Disclosures of Business, Legal Proceedings, and Risk Factors Under Regulation S-K (SEC Release)

Modernizing the Framework for Business, Legal Proceedings and Risk Factor Disclosures (SEC Chair Jay Clayton)

Regulation S-K and ESG Disclosures: An Unsustainable Silence (SEC Commissioner Allison Herren Lee)

Statement on the "Modernization" of Regulation S-K Items 101, 103, and 105 (SEC Commissioner Caroline Crenshaw)

Statement at Open Meeting on Modernization of Regulation S-K 101, 103, and 105 (SEC Commissioner Hester M. Peirce)

Opening Remarks at the Open Commission Meeting to Adopt Amendments to Items 101, 103, and 105 of Regulation S-K (SEC Commissioner Elad L. Roisman)

[C]oral Gables and Coggins solicited investors for a private fund they managed by misrepresenting the fund's past performance, the amount of assets they were managing, and Coggins' experience as a portfolio manager. For example, the complaint alleges that one document Coggins provided to investors and potential investors showed 37 months of positive monthly performance even though, in reality, in approximately 26 months during the specified timeframe the Fund had negative performance. The complaint further alleges that Coral Gables and Coggins falsified brokerage records and investor account statements and created and sent fake audit opinions to investors and third parties. As alleged, within hours of receiving a request from the SEC to preserve documents, Coggins destroyed evidence related to his fraudulent conduct. According to the complaint, Coggins misappropriated investor funds for personal use, including a luxury vehicle and travel.

[F]rom 2012 to 2016, BorgWarner failed to report over $700 million in liabilities associated with future asbestos claims. According to the SEC's order, BorgWarner did not conduct any substantive quantitative analysis to estimate these asbestos claims, despite possessing nearly 40 years of historical raw claims data. According to the order, BorgWarner erroneously relied on untested assumptions in concluding that it could not estimate its liabilities for these claims, including, for instance, that its products were unique among asbestos defendants and that industry benchmarks were inapplicable for purposes of calculating an estimate. The SEC order finds that as a result of this accounting error, BorgWarner's financial statements were materially misstated. As set forth in the SEC's order, in early 2017, BorgWarner reported a charge for these claims and, in 2018, BorgWarner restated its financial statements to report the charges in the appropriate periods dating back to 2012, aggregating $703.6 million related to the asbestos claims. BorgWarner also disclosed that its internal controls over financial reporting were ineffective.

We are adopting amendments to the definition of "accredited investor" in our rules to add new categories of qualifying natural persons and entities and to make certain other modifications to the existing definition. The amendments are intended to update and improve the definition to identify more effectively investors that have sufficient knowledge and expertise to participate in investment opportunities that do not have the rigorous disclosure and procedural requirements, and related investor protections, provided by registration under the Securities Act of 1933. Specifically, the amendments add new categories of natural persons that may qualify as accredited investors based on certain professional certifications or designations or other credentials or their status as a private fund's "knowledgeable employee," expand the list of entities that may qualify as accredited investors, add entities owning $5 million in investments, add family offices with at least $5 million in assets under management and their family clients, and add the term "spousal equivalent" to the definition. We are also adopting amendments to the "qualified institutional buyer" definition in Rule 144A under the Securities Act to expand the list of entities that are eligible to qualify as qualified institutional buyers

We are expanding the definition of accredited investor to include an alternative to the wealth test for natural persons - specifically, persons who hold certain professional certifications and designations and other credentials from accredited educational institutions.  The Commission will be able to designate these by Order based on a number of criteria.  The initial certifications include the Financial Industry Regulatory Authority, Inc. (FINRA) Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82) certifications.  There is no doubt persons who have successfully obtained these certifications - and maintained them in good standing - are sufficiently financially sophisticated to participate in the private markets. 

During the notice and comment period, there have been several criticisms of these modest, incremental efforts to modernize our accredited investor rules that I would like to address.  It has been suggested that expanding the accredited investor definition to include these clearly sophisticated persons will result in more private financings.  Some think this is a positive development, some think it is negative.  When you look more closely, and in particular recognize that there are many segments in the private markets and many types of private financing, it is only positive.  Any expansion in private financing due to these amendments, given the limited nature of the expansion of the accredited investor definition, is likely to be most meaningful in the area of small, local business financing.  Adding clearly financially sophisticated persons to the pool of persons eligible to participate in these financings is a laudable and unassailable policy goal.  Of course, many have asked us to go much further in expanding the pool of eligible investors, citing, for example, the wealth gaps faced by underrepresented founders and the importance of improving access to capital for underserved businesses and communities.  A number of commenters on the Commission's efforts in the private markets space have noted that women, minority and other underrepresented entrepreneurs, as well as those outside of the coastal urban areas where traditional venture capital investment has been more focused, often do not have an existing network of wealthy friends and family and, as result, struggle to access capital. . . .

The accredited investor definition is the single most important investor protection in the private market.[1] Today's amendments purport to "update" that definition while leaving in place 38-year old wealth thresholds, declining to index the thresholds to inflation, and declining to provide economic analysis to show how the failure to index will affect American investors-the bulk of whom are seniors-going forward.

With its actions today, the Commission continues a steady expansion of the private market, affording issuers of unregistered securities access to more and more investors without due regard for the risks they face, and without sufficient data or analysis to ensure that our policy choices are grounded in fact rather than supposition. . . .

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[1] Private offerings lack the traditional investor protections that attach to registration, most importantly transparency and liquidity. Thus, the principal means of protecting investors in private markets is to work to ensure that those offering unregistered securities can only sell to investors who can assess and bear the heightened risks in private markets. Some argue that such an effort is paternalistic and that all investors should be free to risk their livelihoods as they see fit. But that evinces a disregard for the very reason the SEC was created and the fundamental differences between the public and private markets. The SEC's core mission is to protect investors and we should not substitute a policy of "caveat emptor" for meaningfully carrying out that mission.

I support the amendments we adopted today because they are our first steps away from the current, single criterion wealth-based system of eligibility. Nevertheless, I would have supported venturing further down this path of expanding the definition to include knowledge-based eligibility. For example, members of the expert staff we have here at the SEC, who review registration statements for material disclosure and investigate potentially fraudulent activity in our markets, will not qualify as accredited investors because the eligibility criteria are still very limited. It certainly seems a strange outcome that so many individuals who enforce our securities laws and regulate financial markets are not considered sophisticated enough to invest in those very same markets. To me, the conclusion is that our work is not done.

Today's cautious expansion of the accredited investor definition to include additional categories of natural persons and entities is a step in the right direction.  Series 7, 65, and 82 license holders and knowledgeable employees of private funds clearly have the knowledge and expertise to evaluate the merits and risks of an investment.  These newly minted accredited investors are not your typical mom and pop retail investors, a fact that should assuage the concerns of those that fear any expansion of the definition. 

It does not assuage my concerns.  Why shouldn't mom and pop retail investors be allowed to invest in private offerings?  Why should I, as a regulator, decide what other Americans do with their money?  The alleged justification is investor protection: people can't lose their money on investments if they aren't allowed to invest.  Yes, that is true, but where does that principle take us?  Someone who does not invest at all will not lose any money on investments.  She will, however, lose.  She will lose the opportunity to see her money grow more than it could sitting in a bank account.  She will lose the opportunity to be part of enterprises that she believes will transform society.  And she will lose her right to make decisions for herself.

Now, of course, nobody is advocating prohibiting non-accredited investors from investing.  Some people argue, however, that the public markets are the only ones in which non-accredited investors should participate.  Private markets, however, are where a lot of the economic growth is happening.  Moreover, the accredited investor concept has caused the Commission to don a merit regulator's cap, which has-pardon the pun-gone to our head and emboldened us to act as merit regulators in other places too.

The accredited investor concept assumes that individuals cannot be trusted to exercise proper due diligence before making an investment decision and therefore bars individuals from having the investment opportunity in the first place.  Freedom and responsibility are inseparable, so it is no surprise that a regulator that does not acknowledge an individual's ability to bear the consequences of her actions does not respect her liberty interests.  Many commenters reminded us that those liberty interests matter.[1]

For decades, the SEC has permitted wealthy people[2] to make private investments under the theory that their financial sophistication and ability to sustain the risk of loss of investment or fend for themselves render the protections of the Securities Act unnecessary.  This standard was in part developed by the Commission based on the Ralston Purina case, where the Supreme Court held that "[a]n offering to those who are shown to be able to fend for themselves is a transaction 'not involving any public offering.'"[3]  One commenter takes issue with this approach and suggests that whether one can fend for oneself depends on whether one has access to the type of information that would be in a registration statement.[4]  The commenter suggests creating an exemption that makes access to the private markets conditional not on the wealth of the investor, but on the provision by the issuer of a basic set of information about the investment.  This approach might not work because the mandated set of disclosures likely would grow over time.  That said, this potential solution, on which I would welcome feedback from the Small Business Capital Formation Advisory Committee and other interested parties, could help to get us out of the business of deciding who is sophisticated and who is not.

A person's economic status may demonstrate an ability to withstand losses, but it certainly does not demonstrate financial sophistication.  The result of pretending that wealth is a good measure of sophistication is a standard that discriminates against financially sophisticated, lower- income and net worth Americans.  These Americans cannot use their experience, local knowledge, education, and investing acumen to build a balanced investment portfolio, to maximize the nest eggs they pass on to their children, or to invest in their own communities.[5] 

Today's changes are rooted in a recognition that wealth and income are not always great proxies for an investor's sophistication.  The Series 7, 65, and 82 licenses qualified today represent the tip of the iceberg of professional certifications, designations, and other credentials that should qualify an individual for accredited investor status.  Notably, the release invites members of the public to propose to the Commission specific certifications, designations, degrees, or programs of study that should qualify someone to be an accredited investor.  I have concerns with the Commission evaluating the merits of degrees or courses at specific accredited educational institutions.  Such a piecemeal approach would be a huge burden on the Commission and would put it in the odd position of picking winners and losers among educational institutions.  Preferably, applicants would submit proposals that are not limited to a degree or program of study at a specific educational institution.  For example, should the Commission consider qualifying as an accredited investor an individual that has successfully completed two investing-related courses from any accredited college or university?  Direct engagement from the public will be essential to identifying the specific certifications, designations, and other credentials that should qualify individuals as accredited investors. 

Finally, I am pleased that we are expanding the list of entities that qualify as an accredited investor and qualified institutional buyer.  These amendments add a catch-all category for entities owning investments in excess of $5 million and that are not formed for the specific purpose of acquiring the securities being offered.  Indian tribes, which did not qualify as accredited investors under the old rules, will have the ability to qualify under this provision.  I would have preferred an approach that allowed tribes to qualify by counting their assets, instead of just their investments.  One Indian tribe commented that it "does not see a valid reason why corporations or other business entities should be subject to a $5 million asset standard while Indian tribes are subject to a $5 million investment standard."[6]  I, too, do not see a valid reason for applying an asset test to certain entities, while applying an investment test to Indian tribes and other governmental bodies.

Thank you to the Chairman, the staff in the Divisions of Corporation Finance, Investment Management, and Economic and Risk Analysis, and the Office of General Counsel for your hard work on this rule. 

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[1] See, e.g., Letter from Ryan Carpel ("Buying of securities is a right of being an American similar[ly] to voting and exercising freedom of speech."), https://www.sec.gov/comments/s7-25-19/s72519-200972.htm; Letter from Barb Elwell ("We deserve to have [the] same rights and opportunities as wealthy people."), https://www.sec.gov/comments/s7-25-19/s72519-202925.htm; Letter from Greg Hansen ("It is a fundamental human right, especially in America, that people ought to spend and invest their money how they see fit."), https://www.sec.gov/comments/s7-25-19/s72519-202948.htm; Letter from Stuart Kuzik ("All citizens should have the right and ability to invest in developments, redevelopments, or small businesses in their community.  Determining what to invest in and how much of one's capital someone is capable of losing should be an individual and family decision. This is the foundation of capitalism and the freedom our country was buil[t] upon."), https://www.sec.gov/comments/s7-25-19/s72519-7112588-215968.pdf; Letter from Amrik Mann ("I think it is appropriate for everyone who wants to invest should be able to do it. I think that should be the way in any free country."), https://www.sec.gov/comments/s7-25-19/s72519-201108.htm; Letter from Bhavin Shah ("At most the SEC should require disclosure of risk but after that, Americans have the RIGHT to take a risk and lose their money if it so happens to be a bad investment."), https://www.sec.gov/comments/s7-25-19/s72519-7369487-218830.htm; Letter from Davis Treybig ("If we want to maintain the idea of the American Dream, we can't shut off the best performing asset classes to only the wealthiest in America."), https://www.sec.gov/comments/s7-25-19/s72519-201083.htm.

[2] Specifically, under the current definition, individuals qualify as accredited investors if (i) their net worth exceeds $1 million (excluding the value of the investor's primary residence), (ii) their income exceeds $200,000 in each of the two most recent years, or (iii) their joint income with a spouse exceeds $300,000 in each of those years and the individual has a reasonable expectation of reaching the same income level in the current year.

[3] SEC v. Ralston Purina Co., 346 U.S. 119, 125 (1953).

[4] Letter from Andrew N. Vollmer, https://www.sec.gov/comments/s7-25-19/s72519-7677518-222655.pdf.

[5] See SEC Office of the Advocate for Small Business Capital Formation, Annual Report for Fiscal Year 2019, at 42 ("Women, minorities, and rural communities have expressed disproportionate challenges with the standard, which often draws a line between the investors' network and qualification for the most attractive offering exemptions."), https://www.sec.gov/files/2019_OASB_Annual%20Report.pdf. 

[6] Letter from the Southern Ute Indian Tribe, https://www.sec.gov/comments/s7-25-19/s72519-6931445-211588.pdf.

The Securities and Exchange Commission today announced that it voted to adopt amendments to modernize the description of business (Item 101), legal proceedings (Item 103), and risk factor disclosures (Item 105) that registrants are required to make pursuant to Regulation S-K. These disclosure requirements have not undergone significant revisions in over 30 years. The amendments the Commission is adopting today update these items to reflect the many changes in our capital markets and the domestic and global economy in recent decades.

The rules we adopt today build on our materiality-based disclosure framework. The effectiveness of this framework in providing the public with the information necessary to make informed investment decisions has proven its merit time and again as markets have evolved when we have faced unanticipated events. This has been widely demonstrated in registrant disclosures regarding the effects of COVID-19.  We have seen disclosures shift to emphasize matters such as liquidity, cash needs, supply chain risks, and the health and safety of employees and customers. This has served as a reminder that our rigorous, principles-based, flexible disclosure system, where companies are required to communicate regularly and consistently with market participants, provides countless benefits to our markets, our investors and our economy more generally.

One improvement in today's rules I want to highlight is the topic of human capital. I fully support the requirement in today's rules that companies must describe their human capital resources, including any human capital measures or objectives they focus on in managing the business, to the extent material to an understanding of the company's business as a whole.  From a modernization standpoint, today, human capital accounts for and drives long-term business value in many companies much more so than it did 30 years ago. Today's rules reflect that important and multifaceted shift in our domestic and global economy.

Both diversity and climate risk generally fall under the rubric of Environmental, Social, and Governance or ESG risks. ESG investing is no longer just a matter of personal choice. Asset managers responsible for trillions in investments, issuers, lenders, credit rating agencies, analysts, index providers, stock exchanges-nearly all types of market participants-use ESG as a significant driver in decision-making, capital allocation, pricing, and value assessments.These factors have been integrated into traditional analyses designed to maximize risk-adjusted returns on investments of all types. A broad swath of investors find ESG risks to be as or more important in their decision-making process than financial statements, surpassing traditional metrics  such as return on equity and earnings volatility.

In this release and elsewhere, however, the Commission takes the position that it does not need to require or specify these types of disclosures because our principles-based disclosure regime is on the job and will produce any disclosures on these topics that are material. Investors are asked to trust that each individual company has gauged materiality on these complex issues with flawless precision and objectivity.

. . .

There is room for discussion as to which specific ESG risks and impacts should be disclosed and how. But the time for silence has passed. It's time for the SEC to lead a discussion-to bring all interested parties to the table and begin to work through how to get investors the standardized, consistent, reliable, and comparable ESG disclosures they need to protect their investments and allocate capital toward a sustainable economy.

[I] am concerned that today-in the middle of a crisis affecting all aspects of our market-the majority of the Commission is failing to take the opportunity to provide investors with critical and useful information about key corporate metrics. This rule is presented as a "modernization" of certain provisions of Regulation S-K-but the rule before us today fails to deal adequately with two significant modern issues affecting financial performance: climate change risk and human capital. As Commissioner Lee noted in her statement, the final rule is also silent on diversity, an issue that is extremely important to investors and to the national conversation. The failure to grapple with these issues is, quite simply, a failure to modernize.

Although the Commission recognized more than a decade ago the impact that climate change related matters have on certain companies' businesses and operations, today's "modernized" rule will reduce certain environmental risk disclosures by up to 30 percent.And though the Commission has taken a step in the right direction by adding a reference in the final rule to human capital, I worry that the policy choice to impose a generic and vague principles-based requirement will fail to give American investors the information they need about how companies will weather this storm.

The question of whether climate change and human capital are material concerns of investors is no longer academic. The 2019 PG&E bankruptcy after the tragic California fires and the more than $220 billion in damages to the U.S. economy from the 2017 hurricane season demonstrate that the risks posed by climate change are here, real, and quantifiable. Companies know how climate change is impacting their businesses, supply chains and the economy overall; so should their investors.

I would have preferred to eliminate the remaining vestiges of a prescriptive approach, such as the requirement to disclose the number of employees.  That metric-like others some advocated for inclusion under the human capital rubric-might be material for some companies under some circumstances, but not for others.  Investors are likely to receive more meaningful disclosure about a registrant's workforce from the principles-based requirements adopted today.  Regardless, I am encouraged by the incremental reforms in this release, including the modified disclosure threshold for environmental proceedings to which the government is a party that provides registrants with flexibility to select an appropriate threshold.  I view one reform as a bit of an experiment.  We are requiring summary risk factor disclosure if the risk factor section exceeds fifteen pages in length.  Will the penalty of having to prepare a summary be sufficient to overcome the fear of litigation that pushes companies to disclose many pages of risks? 

The amendments we are considering will allow our public reporting companies to present more clearly the information that they consider material in running their businesses.  Such a shift away from dated, prescriptive disclosure requirements to a more principles-based disclosure regime will have tremendous benefits for investors who will now be able to focus their attention on material information that better captures the circumstances of each particular company.

• Securities Industry Commentator
• Bill Singer