Is the Accredited Investor Restriction Unconstitutional Discrimination?
TLDR: no, it’s not, but read the rest if you want to know why.
I recently attended CrowdConverge in Las Vegas and overheard an attendee mention how he believed the very concept of ‘accredited investor’ is discrimination based on income.
For those who don’t know, U.S. securities laws only allow “accredited investors” to invest in certain private offerings. An accredited investor is someone who has made over $200,000 annually for the past two years (or $300,000 with a spouse) or who has a net worth over $1 million.
There’s plenty of debate over whether an accredited investor is “rich” and whether the threshold needs to be increased, decreased or abolished completely (it hasn’t been updated in over 30 years).
What has piqued my curiosity is whether the government can discriminate based on someone’s income. And, given all the recent news about a certain travel ban being unconstitutional for discrimination, I thought it’d be fun to review how and when the government can discriminate against certain people.
So can the government discriminate against you based on how much money you have? After all, by setting a threshold of income or net worth, the government is essentially saying if you don’t make enough money, you can’t invest in certain deals. How can that be constitutional?
Review of Constitutional Law
First, I’m a securities attorney, not a constitutional law expert, so these thoughts are merely for intellectual meanderings. Much of constitutional law revolves around the Equal Protections and Due Process Clauses. Taken together, these clauses ensure that all people within the United States will be afforded equal protection under the law. Basically, the government can’t discriminate against anyone within the US.
However, the prohibition on discrimination is not absolute. There are certain instances where the government is allowed to discriminate against certain groups because the government or the public has a strong interest that needs to be protected as well. For example, the government is allowed to discriminate against criminals by prohibiting convicted felons from buying guns because there is a higher likelihood a convicted felon will purchase a gun to commit a crime in the future. The government’s interest in protecting the public from gun violence vastly outweighs the felon’s interest in owning a gun. How does the government determine when its interest outweighs that of the group being discriminated against?
Standards of Review and Levels of Scrutiny
When weighing the right to discriminates against a certain group, courts have to weigh the law against the rights of the group being affected. Generally, courts will defer less to the government the more the group is one that has historically been discriminated against. This level of deference is called the standard of review. Over the years, Supreme Court decisions have clarified the standard of review for discrimination cases and created three tiers of review based on the class being discriminated against: strict scrutiny, intermediate scrutiny, and rational basis.
Strict scrutiny applies to suspect classes like race, national origin, or religion or when a fundamental right (i.e. a right stated in the Bill of Rights) is being affected. In order to pass a strict scrutiny review, the discriminating law must be justified by a compelling government interest (something necessary or crucial), must be narrowly tailored (can’t be overbroad or have unnecessary side effects), and must be the least restrictive means for achieving that interest (there can’t be another way to achieve that interest that’s less restrictive against the class being discriminated). This is the standard of review the courts will likely apply to the Due Process claims being brought by the recent travel ban cases. (The Establishment Clause claim is entirely unrelated and has its own unique standard of review which I won’t be touching on here.)
Intermediate scrutiny applies to sex-based discrimination like gender, illegitimacy, and sexual orientation. In order to pass intermediate scrutiny, the law must further an important government interest by means that are substantially related to that interest.
Rational basis applies to all other classes and says that the law will be upheld as long as the government has a legitimate interest that is rationally related to the law.
Applied to the Concept of ‘Accredited Investor’
Where does the concept of accredited investor fall? If it is indeed discrimination based on income, then the rational basis review would apply because income is not a suspect class like race or national origin, nor does it affect a fundamental right, nor is it related to a person’s sex. So long as the government has a legitimate interest in limited certain investments to accredited investors, the government is perfectly fine in doing so.
So what is the government’s interest in having a definition for an accredited investor and is the law rationally related to that interest? In order to answer that question, we have to go back to 1982, when the definition was first established. The SEC at the time believed that people who made more than $200,000 or had a net worth over $1 million were sophisticated enough to understand all the risks involved in an investment and as such did not need much protection. The SEC believed that people who did not meet the standard of an accredited investor were not sophisticated enough to understand all the risks involved and should be protected from offerings exempt under Reg D. Also, accredited investors could bear to the risk of loss of an entire investment, whereas grandma’s investment of her last social security check probably does not. Now, whether or not that was or still is true doesn’t’ matter in inquiring whether the definition is constitutional. What matters is whether the government has a legitimate reason that was rationally related to the law. It’s also worth mentioning that whether the reason is based on real quantifiable data is irrelevant; it just needs to be honest and reasonable. The SEC’s protection of non-accredited investors, in light of this line of questioning, is probably a legitimate reason.