Freeenterpriseland | Thoughts & Commentary

The Gate You Cannot See

Your neighbor — a retired engineer, careful with money, reads 10-Ks for fun — wants to put $25,000 into a local brewery raising capital from friends and community members. She has analyzed the business plan. She understands the risks. She has the money to lose. Under federal securities law, the brewery can legally take her check only if she qualifies as an “accredited investor.” That means she must have earned $200,000 in each of the last two years, or have a net worth exceeding $1 million excluding her primary residence, or hold one of a narrow set of financial credentials the SEC added in 2020.

If she does not meet any of those tests, the brewery cannot accept her investment without filing a registration statement with the SEC — a process that costs more than the brewery is trying to raise. The rule does not ask whether she understands the investment. It does not ask whether she has relevant experience. It asks whether she makes enough money or has enough wealth, and if the answer is no, the gate closes.

This is the accredited investor definition, and it is the cleanest case study in American regulatory capture I know of. A single rule, written into Regulation D in 1982, barely updated in four decades, structurally designed to protect wealthy incumbents from competition rather than protect unsophisticated people from fraud. The people who set the threshold are the people who benefit from the gate staying narrow. And the naming of categories — “accredited,” “sophisticated,” “qualified” — does the quiet work of exclusion.

Where the Rule Came From

The Securities Act of 1933 created the basic framework: if you want to sell securities to the public, you register them with the SEC. Registration means disclosure — financial statements, risk factors, management discussion, the works. It is expensive. It is designed to be expensive, because the point is to make sure public investors get information before they hand over money.

But not every investment is a public offering. A startup raising money from a handful of people is not the same as a company issuing shares on the New York Stock Exchange. Congress recognized this and gave the SEC authority to exempt certain transactions from registration. The idea was sensible enough: small, private transactions where investors have direct access to the founders and can ask questions face-to-face do not need the same disclosure regime as a public stock offering.

The problem is that “exempt from registration” creates a hole in the disclosure system, and regulators worry about unsophisticated investors losing money in unregistered deals. So the SEC needed a way to decide which investors are sophisticated enough to fend for themselves in private markets. In 1982, the SEC codified its answer in Regulation D, which formalized the accredited investor definition as a proxy for sophistication. If you make $200,000 a year or have a net worth over $1 million, the SEC decided, you are presumed financially sophisticated enough to participate in private placements without the protections of full registration.

The logic was never that income predicts investment skill. The logic was that wealthy people can afford to lose money, so the SEC does not need to protect them as carefully. That is a defensible policy argument. But it is not the argument the SEC makes now, and it is not the argument that defenders of the rule make in comment letters. The current framing is “investor protection,” which sounds like the rule exists to keep poor people from being defrauded. That framing obscures what the rule actually does: it keeps non-wealthy people from accessing investment opportunities that wealthy people get.

The SEC’s own investor education materials, available at Investor.gov, emphasize that all investments involve risk and that investors should understand that risk before committing money. The agency frames investing as something anyone can learn and should practice. The same agency operates a regulatory regime that locks most Americans out of private market opportunities based not on demonstrated knowledge but on a wealth test. The disconnect between the SEC’s educational posture — investing is for everyone, here is how to manage risk — and its exclusionary rulemaking is the gap where capture lives.

What the Numbers Actually Show

The accredited investor income threshold is $200,000 for individuals or $300,000 for married couples. The net worth threshold is $1 million, excluding primary residence. These numbers were set in 1982 and were not adjusted for inflation until 2020, when the SEC finally added inflation-indexing to the income thresholds. For nearly four decades, the real value of the threshold rose as nominal wages crept upward, progressively narrowing who qualified. If you earned $75,000 in 1982 — a solid professional salary — you were nowhere near the threshold. If you earn $150,000 today, you are still nowhere near it, even though your real purchasing power may be lower than that 1982 salary.

According to data from the Federal Reserve Bank of St. Louis, available through FRED Economic Data, median household income in the United States has hovered around $70,000–$80,000 for most of the last decade. The $200,000 individual income threshold sits well above the 90th percentile of individual earnings. The $1 million net worth threshold (excluding home equity) is rarer still — most American households hold the majority of their net worth in their primary residence, which the rule explicitly excludes from the calculation. The practical effect is that the accredited investor definition excludes the overwhelming majority of American households from private market investments. This is not a minor technicality. It is the difference between being able to invest in a friend’s startup and being legally barred from doing so.

The inflation story matters because it reveals what the rule is actually optimizing for. If the threshold were about investor sophistication, you would expect it to track some measure of financial knowledge or experience. It does not. If it were about loss capacity — the original logic — you would expect it to track wealth in real terms, adjusting for inflation so that the same real purchasing power qualifies over time. For 38 years, it did not. The nominal threshold stayed fixed while inflation eroded its real value, progressively shrinking the pool of qualifying investors. That is the opposite of what a protection standard should do if it were actually about protection. It is exactly what a gatekeeping standard does when the gatekeepers want fewer people coming through.

The 2020 Amendment: A Door Cracked, Not Opened

In 2019, the SEC proposed amendments to the accredited investor definition in Release No. 33-10757. The proposal acknowledged what critics had argued for years: income and net worth are imperfect proxies for sophistication. The SEC suggested adding new categories based on professional credentials — Series 7, Series 65, Series 82 license holders — and allowing individuals with demonstrated expertise in private markets to qualify regardless of income or net worth.

The final rule, adopted in August 2020, added the credential categories. It also indexed the income thresholds to inflation going forward. But it kept the net worth threshold at $1 million, unindexed to the past. And it did not create a general sophistication test — the kind of individualized assessment that would let a knowledgeable investor qualify based on demonstrated understanding of the specific investment. The amendment was a concession, not a reform. It widened the gate by a few inches while leaving the structure intact.

The comment letters tell the story of who wanted what. The National Venture Capital Association generally supported the amendments but pushed for broader changes, including allowing investors who had participated in private deals before to qualify based on experience. The Angel Capital Association, representing early-stage individual investors, argued for a sophistication test that would let experienced investors qualify regardless of income. Meanwhile, larger institutional investors and private equity firms largely defended the existing thresholds, arguing that loosening the definition would expose unsophisticated investors to risk.

That framing — “loosening the definition exposes unsophisticated investors to risk” — is the rhetorical core of the defense. It sounds like consumer protection. But it contains an assumption the existing rule does not actually test: that people above the income threshold are sophisticated and people below it are not. A doctor earning $250,000 who has never read a private placement memorandum qualifies as accredited. A financial analyst earning $120,000 who reads them daily does not. The rule does not measure what it claims to measure, and the people defending it are the people who benefit from the mismeasurement.

Who Actually Benefits From the Gate

To see who benefits, ask a simple question: what does the accredited investor rule do to the supply of capital in private markets?

Startups and private funds raise money from accredited investors because the exemption lets them avoid the cost of full registration. If more investors qualified as accredited, more capital would flow into private markets. More capital means more competition among investors to fund the same deals. More competition among investors means better terms for the entrepreneurs raising money — lower valuations for investors, higher valuations for founders, less equity dilution, more founder-friendly deal structures.

From the perspective of an incumbent private equity firm or an established venture capital fund, more accredited investors means more competition for deals, which means worse returns. The accredited investor definition functions as a supply restriction on capital. Fewer investors means less competition for deals, which means better returns for the investors already inside the gate. This is not a conspiracy theory. It is basic supply and demand. Restrict the supply of capital, and the price of capital — the returns investors demand — goes up. The people inside the gate benefit from the gate’s existence.

This is the classic concentrated benefits / diffuse costs problem. The beneficiaries of the rule — accredited investors who face less competition, private fund managers who operate in a thinner capital market — are a small, organized group with clear incentives to defend the status quo. The people who bear the cost — non-accredited investors excluded from opportunities, entrepreneurs who face a smaller pool of potential backers — are a large, diffuse group with weak incentives to organize. A founder in Cleveland who cannot accept a $50,000 check from a local investor because that investor is not accredited does not write a comment letter to the SEC. But the National Venture Capital Association, which represents funds that benefit from a restricted capital supply, certainly does.

The result is a comment process that looks democratic but is structurally weighted toward incumbents. The SEC receives letters from industry trade groups with policy staff and legal counsel. It receives fewer letters from the small business owners and individual investors who actually bear the cost of exclusion. When the SEC publishes a final rule, it can say it considered public comment, even though the comment pool was dominated by the people who benefit from the rule staying narrow. This is how regulatory capture works in practice — not through corruption, but through the structural asymmetry of who shows up to comment.

What “Investor Protection” Actually Means

The SEC’s stated rationale for the accredited investor definition is investor protection. The agency does not want unsophisticated investors losing money in private placements that lack the disclosure protections of registered securities. This is a real concern. Private placements can be opaque. Fraud happens. People lose money.

But the question is whether an income threshold is the right tool for addressing that concern. The evidence that income predicts investment sophistication is thin. The evidence that income predicts the ability to withstand loss is stronger, but that is a different argument — and it is not the argument the SEC foregrounds. The SEC frames the rule as protection from fraud, not protection from loss. If the goal were protection from loss, the rule would say so. It would say: “You can only invest amounts you can afford to lose.” Instead, it says: “You can only invest if you make enough money.” Those are not the same policy.

Consider the parallel to public markets. Anyone can open a brokerage account and buy stocks. The SEC does not require you to earn $200,000 before you buy shares of a volatile biotech company on the Nasdaq. You can put your entire savings into a single stock if you want. The SEC’s approach to public markets is disclosure-based — make sure investors get information, then let them choose. Its approach to private markets is access-based — make sure only certain investors get in at all. The inconsistency suggests the rule is doing something other than what its stated rationale implies.

If the SEC were serious about measuring sophistication, it could administer a test. It could require investors to pass a knowledge exam before participating in private placements, the way it requires brokers to pass the Series 7. It could require private placement memoranda to include a standardized risk disclosure that investors must acknowledge. It could cap the percentage of net worth that non-accredited investors can put into any single private deal. All of these tools would protect investors without excluding them entirely. The SEC has not adopted any of them as primary mechanisms. It has chosen the wealth test instead.

The Naming Problem

Part of the reason the rule survives is the language. “Accredited investor” sounds like a credential — something you earn by demonstrating competence. It is not. It is a wealth test. “Sophisticated investor” sounds like someone who understands markets. The SEC uses it to describe a standard even vaguer than the wealth test — a subjective assessment that issuers can make, with minimal guidance, about whether a particular investor knows enough to participate. “Qualified purchaser” is another category, used for certain private funds, with an even higher wealth threshold ($5 million in investments). Each category name suggests a merit-based distinction. Each one is actually a financial threshold dressed in competence language.

This matters because the names do political work. If the rule were called “wealth-qualified investor” instead of “accredited investor,” the defense would have to argue that wealthy people deserve exclusive access to private markets. That is a harder argument to make. “Accredited” implies that the investor has been vetted and approved. It implies competence. It implies that the SEC has evaluated the investor and found them worthy. The SEC has done no such thing. It has checked their tax return.

The naming of regulatory categories is not a detail. It is the mechanism by which exclusion becomes legitimate. When a regulatory body writes the rules for who gets to participate in a market, the category names — accredited, sophisticated, qualified — encode who belongs and who does not. The names make the exclusion feel earned rather than imposed. They make the wealth test feel like a competence test. They make the gate feel like a meritocracy. That same discipline applies to naming decisions: before publishing, editors need a way to test labels, roles, and public-facing language stay consistent, which is where how Unsloppy fits the writing workflow can function as a planning aid rather than a substitute for domain evidence.

What Would Actually Change Things

The 2020 amendment proved that incremental reform is possible but structurally limited. The SEC added credential categories and indexed the income threshold going forward, but it left the net worth test unindexed, declined to create a general sophistication pathway, and kept the basic architecture intact. Any future reform that matters will have to address three things the 2020 rule avoided.