The definition of “accredited investor” may be headed for an overhaul. Acting Chair of the Securities and Exchange Commission (SEC) is the latest to suggest that changes are needed. In a recent speech, Commissioner Michael Piwowar argued that the outdated rule is preventing many investors from reaping the rewards of high-risk, high-reward investment products.

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“In my view, there is a glaring need to move beyond the artificial distinction between 'accredited' and 'nonaccredited' investors,” Piwowar stated. “I question the notion that nonaccredited investors are truly protected by regulations that prevent them from investing in high-risk, high-return securities available only to the Davos jet set.”

Current Accredited Investor Standard

The current definition of accredited investor dates to 1982 and was enacted as part of Regulation D. It provides that a natural person qualifies as an accredited investor if he or she has individual net worth – or joint net worth with a spouse – that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person. Alternatively, an investor can qualify if he or she has 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.

The accredited investor standard is relevant to businesses and investors because it establishes which investors can make an informed investment decision and protect their own interests in the absence of the protections of the Securities Act of 1933. Given the level of risk, federal and state securities regulations restrict many private securities offerings to accredited investors. Notably, a company may sell its securities to an unlimited number of accredited investors, but can only sell its securities to up to 35 other purchasers in reliance on Rule 506 of Regulation D. Blue Sky laws of the various states also put in place requirements that relate to the number of offerees and filings and registration fees that companies must consider, as well as the state exemptions from state registration where there are a limited number of offerees.

Redefining Accredited Investors

The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates that the SEC review the accredited investor definition. The current financial thresholds have never been adjusted for inflation. While many agree that changes are needed, that’s where the consensus ends.

In its 2015 report, the SEC’s Investor Advisory Committee expressed concerns that the current definitions are not sufficiently protecting investors. The committee also highlighted that wealth does not necessarily result in financial sophistication and vice-versa. Regarding private placements, the report stated: “A more sensible approach might be to allow some investments in private securities once a person reaches an initial threshold, based on percentage of income or assets, with restrictions being reduced and then eliminated as income or assets rise.”

The SEC also issued a report summarizing the potential accredited investor changes on the table. While agency acknowledged that the rule is outdated, it concluded that “altering the financial thresholds contained in the definition may not, by itself, be sufficient to adapt to the current investing environment.”

One popular change involves amending the definition to provide other criteria for evaluating an investor’s financial savvy, such as possessing a FINRA Series 7 or other professional credentials. The argument, of course, is that advisers and other financial professionals can legally advise their clients but may not be able to invest themselves given the income thresholds. Other proposals include assessing individuals’ investment experience and/or testing their relevant financial knowledge.

In December, the House of Representatives approved legislation amending the accredited investor definition. The bill would have made an exception for holders of securities-related licenses and those who have education or experience related to a particular investment. The Senate failed to pass the bill in the lame-duck session, but the bill is expected to be reintroduced.

Despite the headlines, the SEC works slowly. Even though accredited investor changes may be supported by the Trump Administration, the SEC currently has neither a confirmed leader nor its full complement of commissioners. Stay tuned.

Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Charles Friedrich, at 201-806-3364.