Russ Hooper, a young econ major who was one of my best research assistants, wrote me the following, with permission to quote:
Impossible Foods makes Impossible Burgers, which are vegan burgers that look, taste, and feel like beef burgers. I’m a huge fan of beef burgers, and yet I prefer these. I’m not alone: they’ve been such a hit that Impossible Foods is struggling to meet demand.
I would love to invest in Impossible Foods. I like the product, the potential is huge, and it’s established enough that the risk isn’t enormous. But I can’t, since Impossible isn’t public and I’m not a super-rich investor or venture capital firm. They recently raised another $300M from VCs and celebrities like Jay-Z, Serena Williams, and Katy Perry. I’m not on this list since the SEC won’t allow it.
Isn’t that so frustrating? The SEC is trying to protect me from what I genuinely believe is a good investment. Impossible Foods wants the cash, I want the equity (and to support them), but it’s illegal. However, the SEC thinks it’s ok for people who are already wealthy to invest in the company (and likely get even wealthier in the process). We should all be able to.
Here’s a recent report on Impossible Foods.
I agree with Russ. What he’s referring to is the SEC’s rule on what an “accredited investor” is. This restriction has upset me for a long time, even after I became an accredited investor. For an individual to be an accredited investor and, therefore, legally allowed to invest in entities like Impossible Foods, he/she must have a net worth of $1M or more, not including equity in a home.
I remember my disappointment when Chris Cox, formerly a Republican Congressman from southern California and then the chairman of the SEC, noodled the idea of raising the limits so that an accredited investor had to have a net worth of $2M. Why? Probably something to do with inflation, which had eroded the real value of $1M. But that’s not a good enough reason.
It’s clearly a case of the SEC trying to protect us from ourselves. Yet there are no such rules for betting in Las Vegas. Someone with a $10,000 net worth can go and bet it all on “investments” that are just as risky as, and often riskier than, an investment in Impossible Foods.
The SEC is an elitist organization that enforces privilege.
READER COMMENTS
Charles
May 14 2019 at 12:28pm
“It’s clearly a case of the SEC trying to protect us from ourselves. Yet there are no such rules for betting in Las Vegas. Someone with a $10,000 net worth can go and bet it all on “investments” that are just as risky as, and often riskier than, an investment in Impossible Foods.”
The stock market is not the same thing as gambling and the SEC is a big reason why. Be thankful the SEC has the limited powers it does because without it, you’d be better off with those Vegas “investments”.
Mark Z
May 14 2019 at 11:49pm
Your first clause of your first sentence is true, at least. There is risk associated with investing, but that’s due to uncertainty of the actual profitability of goods/services being produced, not the artifice of whoever runs the game, and with investment there are positive expected returns, while for gambling, there is a negative net return.
Do you have any actual evidence that there are net benefits to preventing people who aren’t tremendously wealthy from being able to invest in non-public companies? Are you concerned about income/wealth inequality? Have you considered that rules like this – that limit investment opportunities for non-rich people (and rich people tend to get a disproportionate amount of their wealth from investment) – are part of the reason for growing economic inequality?
Charles
May 15 2019 at 4:12pm
Hi Mark. Thanks for taking the time to reply to my comment. Good stuff.
“Do you have any actual evidence that there are net benefits to preventing people who aren’t tremendously wealthy from being able to invest in non-public companies?”
Look into the boom and bust of Limited Partnerships during the 1980s.
“Are you concerned about income/wealth inequality? Have you considered that rules like this – that limit investment opportunities for non-rich people (and rich people tend to get a disproportionate amount of their wealth from investment) – are part of the reason for growing economic inequality?”
Definitely but if you want to talk about income/wealth inequality in the context of investing, the discussion should be focused around the discrepancy in taxation between capital gains vs regular income.
Why is capital gains taxed at a lower rate than regular income?
With 40,000,000 Americans living below the poverty line and 70% of all Americans living paycheck to paycheck, who has the money to invest in the stock market?
Wouldn’t it make more sense for this tax discrepancy to be reversed?
David Henderson
May 15 2019 at 4:27pm
You write:
The answer is lots of people. I believe there are approximately 6 to 8 million people in America with a net worth of over $1M, not including housing equity. That leaves a lot of people who are not living in poverty, like Russ Hooper. I happen to know a bit about his situation and I would be surprised if his net worth exceeds $10K. He, and millions like him not in poverty, are prevented from investing in the aforementioned company. So you’ve essentially changed the subject.
You ask:
I think you ask that rhetorically, but there is a substantial literature on this about why taxing capital gains is unfair and inefficient. It amounts of triple taxation whereas taxing regular earned income is single taxation.
Charles
May 16 2019 at 2:35pm
Hi David. Thanks for the comments!
“The answer is lots of people. I believe there are approximately 6 to 8 million people in America with a net worth of over $1M, not including housing equity. That leaves a lot of people who are not living in poverty, like Russ Hooper. I happen to know a bit about his situation and I would be surprised if his net worth exceeds $10K. He, and millions like him not in poverty, are prevented from investing in the aforementioned company. So you’ve essentially changed the subject.”
My comment was in response to Mark’s comment about income/wealth inequality and investing. I think it fits in that context.
“I think you ask that rhetorically, but there is a substantial literature on this about why taxing capital gains is unfair and inefficient. It amounts of triple taxation whereas taxing regular earned income is single taxation.”
Citing “substantial literature” is passing off responsibility for your claim. You should be able to explain how it is unfair and inefficient in simple terms. It is not my responsibility to validate your claim.
Mark Z
May 15 2019 at 10:59pm
Capital gains are already taxed as corporate income. Investment is already at least double taxed in the US. If anything it should be taxed less. How many people are in poverty has nothing to do with this.
But if you really want to even the tax burden, would you be in favor of actually making the ~45% of Americans that don’t pay any federal income tax pay their fair share? Rich people already pay an enormously disproportionate share of federal taxes.
Charles
May 16 2019 at 2:40pm
Hey Mark. Thanks for the reply!
“Capital gains are already taxed as corporate income. Investment is already at least double taxed in the US.”
You are confusing dividends with capital gains. It is an important distinction and invalidates your argument.
“If anything it should be taxed less. How many people are in poverty has nothing to do with this.”
You brought up income/wealth inequality. Capital gains and the larger framework of our tax system is pivotal to that issue.
“But if you really want to even the tax burden, would you be in favor of actually making the ~45% of Americans that don’t pay any federal income tax pay their fair share? Rich people already pay an enormously disproportionate share of federal taxes.”
I never called for an evening the tax burden. Yes, rich people pay an enormously disproportionate amount of the tax burden BUT they also make an enormously disproportionately amount of the income in this country.
Mark Z
May 17 2019 at 6:56pm
“You are confusing dividends with capital gains. It is an important distinction and invalidates your argument.”
No, it doesn’t. Corporations must pay taxes on profits, which ultimately – after taxation – go to investors, whether as dividends or as capital gains. It doesn’t matter which, the argument applies the same.
“You brought up income/wealth inequality. Capital gains and the larger framework of our tax system is pivotal to that issue.”
Are they? There’s evidence from tax-exempt corporate bonds that capital gains tends to covary pretty well with the capital gains tax. You assume that increasing the capital gains tax will yield significant revenues relative to the increase in the rate, which I doubt it will.
“I never called for an evening the tax burden.”
Um, your objection to the lower capital gains tax was that rich people weren’t paying enough taxes, no?
Mark Z
May 17 2019 at 7:08pm
“…significant revenues relative to the increase in the rate.”
I actually mis-wrote this. Meant to refer to incidence rather than revenue; that is, it’s a mistake to assume that the cost of the tax will be borne by investors rather than absorbed by companies (and therefore employees and customers).
Kevin Dick
May 14 2019 at 2:01pm
I am in the VC industry and it’s actually somewhat worse than you describe. Most funds and companies can actually only take investments from 99 accredited investors because of the registration exemption they operate under. (Though there is a new exemption that raises this to 250, but only for very small funds.)
In practice, this means the fund or company has to have pretty high minimum investment amounts–you can’t raise a sufficiently sized fund from 99 sources otherwise. You need adequate diversification and management fees to run an economically sound fund.
But a typical investor shouldn’t have more than 10% or so of their portfolio in this entire _class_ of investment due to the combination of high risk and illiquidity. Let alone a single investment.
So this rule puts such investments even farther out of reach. Or forces people to foolishly concentrate their investment in this asset class–the opposite of the underlying intent.
David Henderson
May 14 2019 at 2:53pm
Thanks, Kevin. Interesting–and upsetting.
Zeke5123
May 14 2019 at 4:07pm
Kevin — I’m not familiar enough with the SEC rules. Can you “get around” the rule by using a fund of fund structure (ie 99 accredited investors invest in partnership A which invests in your master feeder partnership)?
Kevin Dick
May 14 2019 at 9:07pm
@Zeke. No, the SEC is smarter than that. By default, you are required to “look through” such structures and count all their investors as your investors. Potentially, recursing to full transitive closure if there are multiple levels. But if the other fund’s investment in your fund is below a certain percentage of _their_ total assets, you don’t have to look through.
Jeff G.
May 15 2019 at 8:13pm
In a similar vein, the SEC also dictates who can execute day trades or not. A day trade is any round-trip trade (buy+sell) executed in the same day. The SEC says that only people with more than $25K in their account can do this on a regular basis. The rationale is that only people with more than $25K are “sophisticated” enough to engage in this activity. I guess the SEC is implicitly saying that anyone with less than $25K isn’t smart enough to consider transaction costs.
In addition to just being annoying, I always thought this rule probably ended up encouraging riskier behavior for the “unsophisticated.” What if, instead of switching to long-term buy-and-hold strategies, an active trader with less than $25K just adjusted their trading pattern to hold positions for a few days instead of a few hours? Without the ability to exist positions at the end of the day (as many active traders do) they are now forced to hold the (risky) position overnight and end up exposing themselves to more risk than they otherwise would.
Phil H
May 16 2019 at 4:43am
This is utterly bizarre.
There is no rule in the entirety of the US code or the SEC rule book that says this guy Russ cannot buy a part of Impossible Foods. It just isn’t there.
This is a sob story about a government restriction that simply doesn’t exist.
Russ H
May 16 2019 at 2:15pm
How would you propose I invest in Impossible Foods? I’m not an accredited investor and they’re not a public company, likely because SEC filing requirements are so onerous. For them to sell equity to me, they would have to go through similar hoops to becoming public:
Phil H
May 17 2019 at 2:41am
Thank you for asking. If you would like to buy part of a company, I suggest you write a letter or an email to them, asking if you can buy some. That is the normal way we go about voluntary transactions, isn’t it?
Ah, but it’s more complicated than that. What this Russ fellow wants is not just to buy some of the company, but to buy some without getting explicit agreement from the owners. Not very libertarian! So he wants to take advantage of a rather specialized, highly formalized system that some other companies have used, wherein parts of a company are bought and sold almost anonymously and frictionlessly without the need for agreement by the original owners… but he doesn’t want to pay the entry price that this mechanism requires.
My point is that this is an argument about the administrative details of investment law, presented as though it’s an argument about principles. Russ and Henderson may wish that accredited investor status were more easily available. They may be right! But it’s not a question of principle. If Impossible Foods wants to go public (i.e. sell shares to whoever has the money) they will do so. They haven’t done so. That’s them telling Russ: we don’t want to sell to you. This post is Henderson telling them: You should be obliged to sell part of your own company to my friend. It’s not exactly respectful of property rights.
Nick
May 17 2019 at 8:25pm
Really? I would assume that a declined transaction from Impossible Foods (which Russ probably initiated) would be telling him that “we don’t want to sell to you”.
Consider this. What if Impossible Foods themselves ask Russ to invest but doesn’t want to go public? Is it still telling Russ that they don’t want him to invest in their company? I find your notion of consent bizzare. You are somehow twisting the definition of the word ‘voluntary’ and accusing Russ of wanting to take advantage of involuntary actions.
If tomorrow, the government introduced a license to have sex, would you still say that sexual transactions that were prevented because of this were “voluntarily prevented because the actors could have chosen to get the license”? I’m willing to bet you wouldn’t be too happy.
Why does the concept of consent vary in both these scenarios?
Phil H
May 17 2019 at 9:13pm
“What if Impossible Foods themselves ask Russ to invest but doesn’t want to go public?”
This is a reasonable question, but before I answer it, we should remember: it’s a hypothetical. In reality, IF has never heard of Russ, and has no particular desire that he invests. I don’t mind talking about hypotheticals, but it’s always important to bear in mind what the reality of the situation is at the same time. (You bring up a comparison to sex, and it’s an important one: Russ *has not* asked for consent. We can talk about what might happen if he did, but the reality is he has not. That’s a pretty important point!)
Now, to answer the question: If IF wants Russ to invest, but doesn’t want to go public, then they can do so, no problem. They can sell Russ a bit of the company for whatever price they agree. That’s legal. All this “Regulation D” stuff doesn’t prevent anyone from selling a part of their company to another person.
On your sex analogy: First, let’s remember reality. Sex has been ‘licensed’ for much of history. Sometimes by government, often by religious authorities (Scarlet Letter, adultery laws, homosexuality laws, etc.). I agree that it’s better when governments don’t interfere with sex, but let’s not pretend that it’s some absurd idea that no-one could possibly entertain. It still happens all the time, in many countries around the world.
Second, companies are a bit different from sex. The limited company was invented approximately 400 (500?) years ago. It’s a technology. I agree with you that the economy seems to run better when governments minimize their interference with the ownership of companies, but it’s not the same kind of thing as sex, which I think can reasonably be regarded as a human right, or a part of human nature.
Third, and perhaps most importantly, it is an error to say that the government is preventing company transactions from happening with its licensing program. Evidence: many many more company transactions happen now than happened before these programs were introduced. The licensing that the government does in reality makes it possible for more beneficial economic activity to happen.
All of which is not to say that I actually disagree with Henderson on this. To be honest, it’s a technical question which goes beyond my level of knowledge. It may be true that stock markets would work even better if this particular Regulation D transaction had more relaxed rules. But it’s a technical issue, not a matter of principle. There is no moral/economic/liberty principle that says Russ must have the right to buy a bit of IF without entering into any negotiations with IF.
Jeff G.
May 16 2019 at 2:19pm
It’s called Regulation D and you see for yourself here.
Michael Sandifer
May 18 2019 at 9:12am
As a former stockbroker, I’ve long shaken my head at rules for investors that, for example, make it illegal to buy shares of stock with a credit card, but perfectly legal to start a business with one. Which is more likely to lose money? And investment in Google, or one in a new start-up?
Charles
May 21 2019 at 1:04pm
Hey Mark. Thanks for the reply.
“No, it doesn’t. Corporations must pay taxes on profits, which ultimately – after taxation – go to investors, whether as dividends or as capital gains. It doesn’t matter which, the argument applies the same.”
Please give this quick investopedia article a read. This is fundamental to our discussion – https://www.investopedia.com/ask/answers/033015/there-difference-between-capital-gains-and-dividend-income.asp
“Are they? There’s evidence from tax-exempt corporate bonds that capital gains tends to covary pretty well with the capital gains tax. You assume that increasing the capital gains tax will yield significant revenues relative to the increase in the rate, which I doubt it will.”
I did not say that increasing capital gains will yield significant revenue. You’re getting caught up in a technical discussion of tax arbitrage.
What’s important is the big picture; why do we give preferred tax treatment to passive income when 70% of Americans live paycheck to paycheck (aka active income)?
“Um, your objection to the lower capital gains tax was that rich people weren’t paying enough taxes, no?”
My objection to capital gains tax is not that “rich people weren’t paying enough taxes”. I’m all for people to have the opportunity to make money. Again, I don’t think that tax breaks for passive income is a fair tax system.
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