3c hapter - Index of

Blue Skies, Pipe Dreams, and the Lure of Easy Money 23
from federal regulations. It also created an “accredited investor”
category. In addition to insiders and institutional investors, the
defi nition encompassed affl uent individuals who, by dint of their
wealth and the fi nancial sophistication that implied, did not
require the protective coddling of the SEC. Private companies
were now free to raise money from these well- heeled investors
without going through a costly registration process. 5
Just like that, the universe of investors was cleaved in two. If
you had a net worth of $1 million or more, or annual income of at
least $200,000 (later amended to $300,000 for couples), you were
among the top 2 percent of Americans and could invest in pretty
much anything you like. 6 The rest—the vast majority of Americans
who failed to meet that standard—were free to buy publicly traded
stocks, bonds, and mutual funds but were effectively barred from
a wide range of investment opportunities in small, private ventures
deemed too risky. Hereon, there would be two sets of rules
for investing. 7
To use Michael Shuman’s colorful analogy, it was the same
philosophy that led to Prohibition: If you cannot be trusted to
drink responsibly, we will ban drinking. If investors could not be
trusted to invest their money wisely, the SEC would ban them
from risky investments. Happily, reasonable minds prevailed and
Prohibition was repealed in 1933. But we are still left with our
dual- class investor system.
To be fair, it is not an outright ban. The SEC over the years
has carved out exemptions that make it easier for small companies
to raise money from the public without the burdens of registration
and ongoing reporting requirements. But there is an Alice
in Wonderland- like madness to the rules, which inspire as many
interpretations as there are legal experts. Reg D contains three
different exemptions for small offerings of under $1 million or
$5 million. But two of them (Rules 505 and 506) limit the number
of nonaccredited investors to 35, and those folks must be supplied
with similar documentation and disclosure as would be required
in a registered offering, so many companies stick to accredited
investors to simplify matters. There are also prohibitions
on soliciting the general public (as Dante Hesse did when he