Why is the right to buy a private placement decided by how much money you already have?
Abstract
American law lets a company sell shares without registering them and restricts the sale to accredited investors, a status an individual reaches chiefly by earning or owning enough. This paper asks what such a gate could be justified by, separates three candidate grounds, and argues that the wealth test fits none of the ground the courts actually gave for it. The rule's own drift, from 1.8 per cent of American households in 1983 to 18.5 per cent in 2022 with no decision taken, is the evidence that it was never operating as the test it is described as.
A company selling shares to the public in the United States must register the offering and publish what registration requires; a company selling the same shares privately need not. The exemption is no sideshow: Rule 506 alone accounts for about 99 per cent of the capital reported raised under Regulation D.1 It comes with a condition, that the buyers must mostly be accredited investors, and an individual reaches that status by having income of at least 200,000 dollars in each of the last two years, or a net worth above a million dollars excluding their home.2 What could such a gate be for, and is that test a fit instrument for any answer?
Start with the ground the courts gave. In 1953 the Supreme Court decided whether Ralston Purina, having sold stock to several hundred of its own employees unregistered, could claim the exemption. The exemption, it held, turns not on how many people were approached but on whether the class of persons affected need the Act's protection, so that an offering to those shown to be able to fend for themselves is not a public offering.3 That is a claim about competence and, a later appellate decision added, about information: sophistication is no substitute for access to what registration would disclose.4 The law's stated reason is a claim about knowledge.
Only three grounds can justify forbidding a competent adult a voluntary trade in a security, and separating them matters, because each implies a different instrument. The first is that the buyer cannot evaluate what is being sold: an information problem, and the one Ralston Purina names. The second is that the loss will not stay with the buyer but will land on a deposit insurer, a pension scheme or a public safety net: an externality. The third is that the buyer may be perfectly competent and the loss entirely theirs, and the state forbids the trade because it judges they will regret it: paternalism, not automatically wrong, but to be argued in its own name rather than smuggled in under the others.
A wealth test answers none of the first. Having a million dollars is not evidence of being able to read a private placement memorandum, and a securities lawyer earning 150,000 dollars a year is excluded by a rule that admits a lottery winner. What income and net worth do measure, tolerably well, is the capacity to absorb a loss without being ruined by it. That belongs to the second and third grounds. The law states an epistemic justification and deploys an instrument fitted to a prudential one.
If the mismatch were merely untidy it could be forgiven as a cheap proxy. The rule's history shows it is not untidy but unmonitored: the thresholds were set in 1982 and have never been indexed to prices. Reviewing the definition in December 2023, the Commission's staff estimated that about 1,510,000 American households, some 1.8 per cent, met the test in 1983, and about 24,300,000, some 18.5 per cent, met it in 2022, attributing the increase largely to the thresholds not having been adjusted for inflation.56 So the share the law treats as able to fend for themselves rose tenfold without anybody deciding that Americans had become ten times better at reading a placement memorandum. A competence standard that widens tenfold through the ordinary action of rising prices was never operating as one.
Each ground names its own instrument. If the ground is competence, the instrument is a competence test, and American law has taken a first step: since December 2020 a person holding a Series 7, Series 65 or Series 82 licence in good standing qualifies whatever their wealth.7 If the ground is that the loss travels, the instrument is not a gate but a ceiling, and American law has that too: under Regulation Crowdfunding a person who is not accredited may invest the greater of 2,500 dollars or a percentage of their income or net worth, subject to a ceiling of 124,000 dollars over twelve months.8 A ceiling lets a person make the trade and limits what it can do to them, which is what loss-bearing capacity implies. If the ground is paternalism, the honest course is to say so, which citing Ralston Purina cannot do.
The Commission is now considering the competence instrument in earnest, which makes the distinction operational. On 30 September 2026 it proposed designating further credentials under the rule, among them certified public accountants, chartered financial analysts and certified financial planners, and asked whether passing an examination to be developed by FINRA, valid for ten years, should qualify a person.910 Comments close on 4 December 2026 and nothing has yet changed.10 But notice what an examination route does to the two grounds the wealth test had held together. Somebody who qualifies by examination has demonstrated competence and nothing whatever about their capacity to absorb a loss. For wealthy entrants the conflation was harmless, because the wealth that failed to prove competence did prove solvency. For examination entrants the two come apart, so an examination pathway without a ceiling would answer the information objection and abandon the prudential one, for exactly the people to whom it applies most strongly.
The strongest objection is administrative. A wealth test is cheap, verifiable and hard to fake; a competence test is costly and invites coaching; and wealth buys access to advisers who supply the competence the buyer lacks. All true, and a good argument for using a proxy. It is not an argument for misdescribing what the proxy stands in for, because a rule nobody states plainly is a rule nobody notices drifting, which is how 1.8 per cent became 18.5 per cent unremarked across four decades. And if purchased advice is what the test is really buying, the rule should condition on the adviser rather than the balance sheet, which the credential route shows is possible.
Britain supplies the other half of the argument by having tried to move the bar. From 31 January 2024 the exemptions letting firms promote unlisted investments to individuals required income of at least 170,000 pounds, up from 100,000, or net assets of 430,000, up from 250,000.11 Within weeks the government reversed itself, reinstating 100,000 and 250,000 and the previous sophisticated-investor criteria, over the recorded disagreement of the Financial Conduct Authority.1213 Raising a competence bar reads as consumer protection; raising a wealth bar reads as reserving an opportunity for the already rich, because that is what it does.
What follows is specific. A jurisdiction keeping a wealth test should say it is a loss-bearing test and defend it as one, which means indexing it, because an unindexed prudential threshold erodes exactly the buffer it was written to require. A jurisdiction wanting a competence test should build one and pair it with a proportional ceiling, since competence and solvency are different properties and only one would be under examination. The falsifiable prediction: if an examination route is adopted without exposure limits, the complaints arriving within a few years will be about losses borne by people who passed the examination, not people shut out by failing it.
Notes
1For Rule 506 accounting for almost all of the capital reported raised under Regulation D. The Commission's Division of Economic and Risk Analysis put the share at approximately 99 per cent in its 2015 study of unregistered offerings, covering 2009 to 2014; the later white paper, "Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings" (August 2018), was not opened, because sec.gov refused every request from this environment. Summary of the 2015 study giving the 99 per cent figure; the 2018 white paper
2Congressional Research Service, "Accredited Investor Definition and Private Securities Markets," In Focus IF11278, for the income and net worth thresholds applying to a natural person and the exclusion of the primary residence. CRS product page
3SEC v. Ralston Purina Co., 346 U.S. 119 (1953), for the holding that the exemption turns on whether the class of persons affected need the Act's protection, and for the phrase about offerees able to fend for themselves. Justia; Cornell Legal Information Institute
4United States v. Custer Channel Wing Corp., for the statement that sophistication is not a substitute for access to the kind of information registration would disclose. Justia
5Securities and Exchange Commission staff, "Review of the Accredited Investor Definition under the Dodd-Frank Act," 14 December 2023, for the 1983 and 2022 household estimates and for attributing the increase to unindexed thresholds. This environment's network policy blocked sec.gov, so the figures quoted here rest on the report as quoted by the two independent summaries at note 6. SEC report page; report PDF
6Ballard Spahr, "Review of the Accredited Investor Definition Under Dodd-Frank," January 2024, and Cooley, "SEC issues staff report on definition of accredited investor," 18 December 2023, both quoting the staff report's figures of 1,510,000 households or 1.8 per cent in 1983 and 24,300,000 or 18.5 per cent in 2022. Ballard Spahr; Cooley
7Securities and Exchange Commission, "Accredited Investor Definition," final rule, Federal Register, 9 October 2020, for the designation of the Series 7, Series 65 and Series 82 licences, the treatment of knowledgeable employees, and the refusal to permit self-certification of sophistication. Federal Register; govinfo PDF
8Securities and Exchange Commission, Division of Corporation Finance, Regulation Crowdfunding compliance guide, for the investment limits applying to investors who are not accredited. These figures are adjusted for inflation periodically and sec.gov was unreachable from this environment, so the current text of 17 CFR 227.100 could not be checked for the 2026 values. SEC compliance guide
9Securities and Exchange Commission, proposing releases 33-11445 to 33-11449, all of 30 September 2026, on expanding the certifications, designations and credentials that qualify a natural person as an accredited investor. The examination is proposed in 33-11445 and the professional credentials in the four releases that follow, on the account cited at note 10. sec.gov refused every request from this environment, so none of the releases was opened. Release 33-11448
10A&O Shearman, "SEC proposal: expanded accredited investor eligibility for natural persons," October 2026, for the credentials under consideration, the FINRA-developed examination and its ten-year validity, the 4 December 2026 comment deadline, and the point that the only designations currently in force are those made in 2020. A&O Shearman note; Ropes and Gray note
11Burges Salmon, "Changes to high net worth and sophisticated investor exemptions," on the thresholds that took effect on 31 January 2024. Burges Salmon
12Burges Salmon, "High net worth and sophisticated investor exemptions: changes reversed," on the reinstatement of the 100,000 and 250,000 pound thresholds, the restored sophisticated-investor criteria, the validity of statements until 30 January 2025, and the Financial Conduct Authority's recorded disagreement. Burges Salmon
13Herbert Smith Freehills Kramer, "Financial Promotion: U-turn on UK high net worth individual and sophisticated investor exemptions," March 2024, corroborating the reversal and its timing. HSF Kramer note