Facebookonomics, The Accredited Investor Rule And The Umbrage Of Ezra Klein

Thanks to Tam for her post on Ezra Klein's umbrage over Facebook's IPO, I got a chance to read her erudite and witty smack down of his disingenuous article, and it lead me to think about what Mr. Klein is really complaining about.

In his article he states:

But to have gotten a big chunk, and to have gotten it early, when Facebook wasn’t a $100 billion company, you had to be rich and well-connected. You had to have millions of dollars to start with, and you had to be the kind of guy that every entrepreneur in Silicon Valley would do backflips to take a meeting with.

This, really, is the story of modern income inequality in America: the rich and the powerful and the well-connected getting richer and more powerful and more well-connected. You heard the line "the rich get richer"? Well, this is how they get richer.

The real funny thing about this outrage on his part is that it's the guys on his side of the political fence that stop the average mom, pop, uncle and auntie from investing money in the initial stages before they go public and thus stop them from both probably losing their shirts but also from reaping such high returns.

Allow me to explain:

Look up the term "accredited investor".

The main part of the rule states:

"The federal securities laws define the term accredited investor in Rule 501 of Regulation D and as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act as:

a bank, insurance company, registered investment company, business development company, or small business investment company;

an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;

a charitable organization, corporation, or partnership with assets exceeding $5 million;

a director, executive officer, or general partner of the company selling the securities;

a business in which all the equity owners are accredited investors;

a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, excluding the value of their primary residence;

a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or

a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes."[1]

That's the rule that prevents anyone from investing in such risky start ups unless they have the appropriate annual income or a million dollars in net worth, not including their primary residence. That rule was put in place starting in 1933, by Democrats, and the increase in qualification amounts and the residence exclusion were just added under Dodd-Frank to keep ordinary people out of these investments.

You know, for their own protection.

That does tend to remove the vast majority of people from being able to invest. Its not being rich and connected that lets people in on these deals - it is that by law its illegal to even let you in on the deal. If the company tries to let you and you don't meet these qualifications, they're committing a criminal act.

Of course, accredited investors turn out to be not so sophisticated after all, and tend to lose their money on such speculative investments in impressive fashion. Of course they're allowed to try and often times they hit it out of the park.

It's when they make such a home run, of course, when people like Ezra Klien come along and bewail the lack of opportunity for the average person to get in on such deals. When they lose millions on the deal, not so much.

It's a little hard to rail against the lack of ordinary people to get in on such an opportunity when its your own side's policies that's stopping them from doing so. But then again, Klein and friends don't seem to have an issue with that.