SEC Commissioner Peirce Offers Recommendations To Increase Participation In The Financial Markets – Finance and Banking

In an address before the FINRA Certified Regulatory and
Compliance Professional Program, SEC Commissioner Hester M.
Peirce considered solutions for enhancing retail
investors’ access to the financial markets and reducing
employment barriers in the financial industry.

Ms. Peirce urged regulators to assess why, despite the U.S.
financial markets generating substantial returns, only half of
American households (i) directly own equities or (ii) own mutual
funds or exchange-traded funds. Ms. Peirce suggested that the low
level of market participation is in part a result of poor financial
education. She also argued that Accredited Investor, Qualified
Client and Qualified Purchaser eligibility were impediments to
participation in the financial markets by investors of limited
means. She stressed that such barriers prevent most Americans from
participating in private markets, which deprives them of the
opportunity to invest in companies with the potential to generate
significant early gains, particularly since companies are waiting
longer to go public. Rather than more heavily regulating private
markets to push companies to go public, Ms. Peirce stated that a
simpler approach would be to remove the existing barriers. She
remarked that such barriers do not just exist for retail investors,
but for small companies in areas without a significant pool of
wealthy investors. Accordingly, Ms. Peirce urged the SEC to adopt a
tailored regulatory framework for individuals to act as
“finders” to match small companies with investors, either
through its 2020 proposed exemptive order or by a
rule.

Ms. Peirce also addressed barriers to financial industry
employment. She pointed to the Exchange Act’s statutory
disqualifications for employment as an associated person of a
broker-dealer, including the barring of individuals with any felony
convictions or certain misdemeanors within the previous 10 years,
as an unreasonable barrier considering how “remarkably
easy” it is to commit a felony in the United States.
Additionally, Ms. Peirce noted the requirements in FINRA’s Form
U4 and the SEC’s Form ADV for an applicant to report any
offense charges, even if they have not resulted in a conviction, as
“an unreliable guide to a person’s character” and
irrelevant from a regulatory perspective. Ms. Peirce also cited the
SEC’s and FINRA’s punitive approach to compliance officers
in enforcement actions, emphasizing that such actions can sometimes
lead to professional and personal devastation that can prevent
people from being comfortable entering the industry.

Ms. Peirce noted the substantial increase in retail
participation in individual equities and options trading as a
result of new technologies, including mobile apps, artificial
intelligence and stablecoins. She emphasized that as a result, a
new generation of retail investors is getting a cheap, accessible,
convenient and high-quality hands-on financial education that
previous generations did not have the opportunity to receive.

CommentarySteven Lofchie

There is one investor qualification definition that even an SEC
that favors investor protection over investor choice should
reconsider: “Qualified Purchaser.”

Generally, “accredited investors” (which is a fairly
low standard of wealth and income) are permitted to invest in
private funds exempt from registration under the Investment Company
Act by virtue of Section 3(c)(1), which limits these funds to less
than 100 investors. To invest in a Section 3(c)(7) private fund,
which has no limit on the number of investors, an investor must be
a “qualified purchaser” (which imposes a significantly
higher standard of wealth requirement). Many of the better
established funds rely on Section 3(c)(7) and so are not available
to mere accredited investors.

The effect of this two-tier standard is to the detriment of
retail (accredited) investors. They are effectively relegated to
investing in funds that may have only other retail investors who
cannot provide the same level of due diligence as can institutional
investors. By allowing accredited investors to invest in all
private funds, and not limiting them to private funds that may be
effectively only for smaller investors, the SEC would allow these
investors to piggyback off the benefits of the more substantial
diligence that is performed by institutions.

As a practical matter, this is the way that the stock markets
work. However much retail investors may read offering documents, in
fact their greater protection probably derives from the fact that
public market prices are largely set by institutions and retail can
piggyback off of institutional valuations. Private funds should
work the same way: retail investors should be permitted to
piggyback off of the diligence performed by institutions.

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