THE DEMOCRATIZATION OF HIGH RISK INVESTING

Since the days of Ronald Reagan, Congress has been looking for ways to put more money in the hands of business people. More specifically, Congress has wanted people who are not accredited investors to be able to make high risk investments.The philosophy behind the idea is simple. Businesses create jobs and wealth, and so the best way to improve the economy is to put more money into the hands of business people. Often, this view is presented as being the antidote for alleged liberal concepts of big budget government.Right now, most high risk investment opportunities are limited to accredited investors. An accredited investor is someone who has sufficient net worth and income to be able to afford making risky investments. If an accredited investor makes an investment and loses the whole bundle, their lives will pretty much go on unaffected. High risk investments are attractive because such investments are the only way to significantly improve the earning potential of an investment portfolio. Or so the reasoning goes.The standards defining who can qualify as an accredited investor were established in 1982, and have not been revised since. An individual qualifies as an accredited investor if they earned $200,000 this year and expect to do so next year (or $300,000 when combined with a spouse) or has a net worth of $1,000,000 excluding their primary residence. Certain companies and institutions can also qualify as accredited investors.The JOBS Act is government’s latest attempt to put more money in the hands of business people. Simply put, the goal of The JOBS Act is to allow unaccredited investors to make the same kind of high risk investments that used to be limited to accredited investors. The first step this year was the publication of new rules for Regulation A offerings, which are open to both accredited and unaccredited investors. These so-called Reg A+ offerings make it easier for offerors to raise up to $50,000,000 from unaccredited investors by bypassing any and all state oversight. The second step was the publication of new rules allowing offerors to sell securities to unaccredited investors over the internet through equity crowdfunding portals.So, very soon, unaccredited investors will be able to make a lot of small high risk investments. The selling point is that these investors should have the same ability to increase the returns on their portfolios as accredited investors. But let’s be honest, unaccredited investors have not been lobbying for these changes in our investment rules. Big business has been pushing for these changed because they need capital.What concerns me is that most attempts to put more money into the hands of business have yielded disastrous results. In the 1990s, it seemed like a good idea to remove the safeguards keeping banks from getting into risky investments. Because it put more money in the hands of businesses, and businesses create jobs and wealth. So banks started making high risk bets on credit default swaps that, let’s face it, they didn’t really understand. And they started giving mortgages to people who, let’s face it, did not have the ability to pay them. Eventually, in 2007 the banking industry all but collapsed when those high risk investments failed, and the Great Recession began.Since history generally repeats itself, I don’t have high hopes for those unaccredited investors who are now going to be able to make high risk investments. Certainly, some people are going to get rich, but it won’t be these investors. Their money will be used to pay the expenses and salaries of people who are trying to launch new businesses, most of which will fail.In yet another move towards making high risk investing available to all, the SEC announced plans to update the definition of “accredited investor.” SEC Chairwoman Mary Jo White told Congress that the definition of “accredited investor” will be expanded to include lower net-worth individuals who have the sophistication, experience and qualifications to evaluate risky investments. What this will do is allow more people to bypass the meager protections left to unaccredited investors by deeming them accredited investors. When these investors make a high risk investment through an equity crowdfunding portal, there will be no limit on how much they can invest.So, as equity crowdfunding emerges over the next 5 years as the primary way business gets financed, be prepared for some horror stories. I just hope that the abuses of the system don’t hurt honest business people. Like legitimate theatre producers.