Becoming an Accredited Investor
30 June 2016
For nearly three and a half decades what defined a person as an accredited investor had remained relatively unchanged. In 1982 the Securities and Exchange Commission (SEC) established income and wealth guidelines under its Regulation D framework, which essentially regulated who would be permitted to invest in private placement offerings.
The theory behind the SEC establishing such guidelines was that wealthy persons, above a certain threshold, were "sophisticated" enough to manage their financial affairs, when it came to monetarily backing new businesses. Since the Great Depression era, federal securities laws have attempted to protect lower-income individuals who might be less informed about business finance from losing money on new start-up investments. With a more than 90% historical business start-up failure rate, it was assumed that wealthy individuals had the knowledge base to have a better understanding of what they were investing in and could absorb potential financial losses.
Regulation D (Reg D), Rule 501, itemizes specific criteria which would identify who is considered an accredited investor.
In order to be considered an accredited investor, according to SEC Rule 501(a) of Regulation D, a person has to meet at least one of the following:
- An individual annual income and total net worth of $200,000, in the most recent two-year period.
- If married, have an annual income and total net worth of $300,000 in the two most recent years.
- Either individually or jointly with a spouse, have a net worth of $1,000,000, excluding the value of an investors primary residence.
- Be a general partner, director, executive officer, or a related combination thereof for the issuer of a security being offered.
- A trust with total assets of $5,000,000 and above. The trust must not have been formed for the purpose of purchasing offered securities and must be controlled by a "sophisticated" person.
- An entity where all equity owners are themselves accredited investors.
- A non-profit 501(c)(3) organization with assets in excess of $5,000,000.
- A Private Business Development Company as defined in the Investment Advisers Act of 1940.
- A bank, savings and loans, insurance company, an investment company registered under the Investment Company Act of 1940, a Small Business Investment Company licensed by the US Small Business Administration, a plan established and maintained by a state with assets in excess of $5,000,000, an employee benefits plan with assets in excess of $5,000,000, or a self-directed plan managed by an accredited investor.
Why is being considered an accredited investor important?Being a qualified accredited investor is significant because accredited investors are allowed, by federal securities laws, to participate in investment opportunities that are not registered with the U.S. Securities and Exchange Commission (SEC). These opportunities are generally not available to non-accredited investors. Rule 506, of Regulation D, does permit up to 35 non-accredited investors to participate in a company's capital raise. However, because of the extensive filing and offering disclosure requirements established by Rule 502(b) of Regulation D, and inherent cost attached thereto, the practicality of including non-accredited investors makes this avenue prohibitive. In effect, non-accredited investors are locked out of the opportunity to get in on the ground floor of start-up companies that may one day become the next Google, Facebook, Amazon or Uber.
House of Representative approves expanded 'Accredited Investor' definitionOn February 1, 2016 the U.S. House of Representatives overwhelmingly voted to approve a house bill that would amend the U.S. Securities Act of 1933 to include the Fair Investment Opportunities for Professional Experts Act (H.R. 2187). The bill is currently referred to the U.S. Senate's Committee on Banking, Housing and Urban Affairs for review. If this bill is ultimately approved into law, it would open up the ability for some non-high-net-worth individuals to financially support startups. It accomplishes this by mandating the SEC to widen their definition of an accredited investor to include a knowledge and education-based category of accredited investors. This change allows those who are considered experts in the field of investment and finance to be accredited investors, in their own right. According to the SEC's Investor Advisory Committee, "expanding the pool of eligible investors that can participate in private placements will increase capital formation and amending the definition of accredited investor to account for educational or professional expertise will help to increase that eligibility pool. Individual investors that have the risk appetite and ability to understand the private offering should be able to invest - the government should not limit the options of individual investors to only those the government deems worthy."
These persons would include:
- Any natural person who is licensed in the securities industry (registered broker or investment adviser with the SEC), Financial Industry Regulatory Authority (FINRA), or the securities division of a state or an equivalent state division.
- Any natural person whom the SEC determines by regulation to have demonstrable education or job experience to qualify a person as having professional knowledge or a subject related to a particular investment, and whose education or job experience is verified by FINRA or an equivalent self-regulatory authority.
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