William Carleton, Counselor @ Law

The accredited investor definition, after the Supreme Court strikes down DOMA

We're going to adjust tactics in the startupequality.org campaign, working off the premise that the Supreme Court will strike down DOMA sometime this month.

None of us are professional Court prognosticators, but, surveying the predictions of some of those who are, we are presuming that the Court will hold that the federal statute cannot override the policies of the various states as to who may and may not marry.

This means, we think, that "spouse" for purposes of federal laws and regulations will have to mean any person's spouse in any marriage, regardless of that person's gender. (Right now, because of DOMA, "spouse" under federal law has an attenuated and openly discriminatory definition, expressly requiring that a "spouse" be of an opposite gender.)

With respect to high net worth individuals in same sex marriages, the overturning of DOMA in such a manner probably solves the problem: "spouse" under SEC Rule 501 of Regulation D will simply have a natural and intuitive meaning. If you're married, you're married.

Less clear are those situations where the legal relationships between same sex partners are something other than marriage. These legal relationships include, but probably are not limited to, domestic partners, designated beneficiaries, and parties to a civil union.

We think that, immediately following the overturning of DOMA, the SEC should issue an interpretive release or guidance, to the effect that, for all purposes of the accredited investor definition, "spouse" will include not just spouses in marital relationships, regardless of gender, but also domestic partners, designated beneficiaries, parties to a civil union, and all other persons to whom any applicable law (federal, state or local) extends economic benefits.

Photo: HystericalMark / Flickr.

If DOMA is overturned, will the discrimination in the accredited investor definition go away?

I don't think so.

It's possible that the President, or the heads of various agencies, could take action, or simply clarify, that references to "spouse" in administrative regulations apply equally to same-sex spouses.

Even so, what of persons in same-sex relationships who would marry, but cannot, legally?

To address the problem of the insidious discrimination in the accredited investor definition, either the term "spouse" will need to be removed, or a constructive definition arrived at.

I'm not sure which solution is better.

I am sure, however, that there will be broad consensus in the angel investing community that the sexual orientation discrimination in the SEC rule is repugnant.

To learn more about this issue, go to http:\\startupequality.com.

Tip of the hat to Doug Cornelius for pointing out how DOMA skews the law.

Photo: Mark Fischer / Flickr.

Letter to SEC on marriage bias in startup investing

Joe Wallin and I are preparing a letter, addressed, we think, to Mary Jo White, the new head of the SEC, calling her attention to an unfair bias against same-sex couples, embedded in the accredited investor definition of Regulation D.

The basic problem is this: meeting the accredited investor standard is easier if you are in a heterosexual marriage; but if you are in a same-sex relationship and not allowed to marry, you have to meet a higher standard imposed on single people.

That's not right, and, in our opinion, not lawful.

It's also just plain stupid policy for America's innovation economy.

Why make entrepreneurs tell angels in same-sex relationships that their money is not as good as the money of married heterosexual couples?

Housekeeping

Couple housekeeping items today.

First, I wanted to let everyone know that I have updated the statecrowdfundinglaw.com site to add new information about the North Carolina investment crowdfunding bill.

That's the only new development to the site in over a month. If you know of any state initiative - legislative or regulatory - to make investment crowdfunding legal in a given state, let us all know in the comments and I'll add your info to the site. Wikipedia is watching.

Second, I welcome any thoughts on how to escalate, to the SEC and/or the White House and/or Congress, the concern with the bias in the accredited investor definition, which essentially penalizes or discriminates against same sex couples. Is this cause best advanced by a petition, or a Tumblog, or something else?

Photo, "Marie cleaning a balcony," by  ZarrSadus / Flickr.

Same-sex marriage and the accredited investor standard

A question this morning from a client about the accredited investor standard for married couples got me thinking: here is yet one more compelling reason for marriage equality in the United States.

The standard in question reads like this:

"(a) Accredited investor. Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

. . . 

"(5) Any natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1,000,000 [excluding the person's primary residence]. . . .

"(6) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year[.]"

Emphasis added.

Presuming I'm correct to assume that the normative denotation of "spouse" implies marriage, couples in civil unions would not be "spouses" to one another. If the couple wished to be married, but state law didn't permit them to be, then they would be shut out of the ability to combine income or net worth to meet what is effectively a lower accredited investor standard for married couples.

That sounds like discrimination on the basis of sexual orientation, and may violate the Equal Protection Clause of the Constitution.

Well, we know the accredited investor definition and standards are going to be the focus of regulatory revision, sooner than most of us otherwise want, probably. That being the case, a non-discriminatory standard should be changed to refer, not to "spouses," but to "partners."

Or maybe the staff could issue an interpretive release to say that it construes "spouse" to mean couples who are married or, where the law does not allow same sex couples to marry, same-sex couples.

Photo: 1st Marriage Licenses, King County, Washington / Flickr.

Whither general solicitation?

Title II of the JOBS Act called upon the SEC to implement rules lifting the ban on general solicitation in Rule 506 offerings, where all purchasers are limited to accredited investors.

This might have been a relatively straightforward instruction, except that Congress also required that the implementing rules must somehow call on issuers to "verify" the accredited status of the purchasers. While at the time no one actually said or intimated that the industry has seen widespread cheating to get around the accredited investor standard - verification was not a concern when the standard was modified by Dodd-Frank a few years back - several floated a vague presumption that went unchallenged: if issuers are tweeting broadly for angel investors, non-accrediteds will get caught up in the hype and lie, or issuers will be somehow inclined to look the other way, even though they didn't when 506 was "quiet."

In practice, of course, the rule against general solicitation had already been bent back so far, it might fairly have been said to already be standing on its head.

One can imagine, with the FundersClub and AngelList no-action letters showing a model that other accredited crowdfunding platforms might follow, that the formal lifting of the ban on general solicitation might never be relevant: those no-action letters don't discuss general solicitation or accredited investor verification. It's as those the SEC staff assumed the entire discussion was taking place under Rule 506(b).

But other portals for accredited investors will want the ban to be formally lifted as the JOBS Act requires. These will be the angel platforms for which it will make sense to rely on Section 201(c) of the JOBS Act, an exemption from federal broker dealer registration requirements that say it's okay, when dealing only with accrediteds, to generally solicit, transact, co-invest and more. Though this section of the JOBS Act has already found its way into the US Code and has in fact been law since the President signed the bill, the way the law is worded, and the unfortunate SEC staff FAQ about Section 201(c), make it important that the ban be formally lifted. Right now, at least on division of SEC staff would appear to take the position that, while angel platforms can do all the things contemplated by Section 201(c), no issuer could actually participate, lest it violate the ban on general solicitation.

It would seem that angel platforms relying on Section 201(c) will be buying into the "noisy" 506.

Anyway, this recap this morning prompted by the item on Broc Romanek's Corporate Counsel blog this morning, assessing conflicting signs on what new SEC Chair Mary Jo White might do about the stalled out rulemaking on the lifting of the general solicitation ban. Might the new Chair be pushing for adoption of the rules proposed in August as interim final rules, as Bloomberg reports? Hard to say.

Side note and prediction: all the attention on general solicitation and verification will put increased pressure on the accredited investor definition itself. Accredited crowdfunding - whether pursuing the models blessed by the no-action letters or relying on Section 201(c) of the JOBS Act - will in fact be hampered in a big way if regulators find a way to narrow the pool of those who qualify as accredited.

Photo: "General Sir Henry Rawlinson (left) chats with a French War Correspondent," National Library of Scotland's Flickr photostream.

Ditch the income and net worth standards in the accredited investor definition?

At a Congressional hearing last week, SEC Commissioner Elisse Walter made a number of comments about Rule 506 and the accredited investor definition.

Representative Dennis Heck asked Commissioner Walter if the SEC staff were currently reviewing the accredited investor definition, as permitted or called for under Dodd-Frank.

Walter noted some constraints imposed by Dodd-Frank - for example, the net worth standard, as changed by Dodd-Frank, was grandfathered for a period of time - but indicated that the SEC was, indeed, considering how the accredited investor definition might or should be changed.

Here's a transcript (apologies for any transcription errors) of what Commissioner Walter said to Rep. Heck at about the one hour, two minute mark in the archived webcast of the hearing:

“Some of the things we could consider, and I wouldn't rule out others, would be of course raising the numbers that are in the definition.

“Alternatively, we could use a different criterion. I tend to think that if we were to look at the amount an individual had invested, and we're really talking about natural person accredited investors here, we're not talking about entities, but if we were to look at a standard of a person having so much already invested, that prior experience, it wouldn't be perfect, but would be nonetheless an objective indicator that perhaps would be better. 

“We could also look at criteria that are not specifically with respect to the definition. Borrowing from Title III of the JOBS Act, if you look at the crowdfunding provision, there is a provision in there that someone who is going to invest through a crowdfunding site has to go through a process of demonstrating that they understand basic concepts. Essentially an online, it would end up being an online learning module, where you would have to continue to keep going through until you got the answers right, so it would demonstrate a certain degree of knowledge. And we could perhaps consider something like that as well.”

It is the case that regulators, and state regulators in particular, have long pressed for increasing the income and net worth thresholds of the accredited investor definition, or otherwise tightening up and restricting the number of persons who can meet the definition. I think it's also fair to say that the lifting of the ban on general solicitation, and innovations pursuant to Title III of the JOBS Act, put additional pressure on the continuing viability of the current accredited investor definition.

Thanks to Doug Cornelius and Jim Hamilton for posts that flagged this aspect of Commissioner Walter's testimony.