Does the Accredited Investor Definition Need a Makeover?

The definition of “accredited investor” may be headed for some significant changes. The Securities and Exchange Commission’s (SEC) Investor Advisory Committee is the latest group to call for an overhaul. This blogger likes the recommendation described below that restricts investors individually from risking too high a percentage of their personal assets in private placements.  Such a restriction, which does not currently exist, would lessen the risk of an investor over-concentrating investments in private placements. This protection already exists for customers of brokerage firms, by virtue of a FINRA Rule against that can lead to sanctions against brokers who recommend over-concentrated investments in risky registered securities for a customer’s account.  So, why not have it as a self-policing protection for investors making their own decisions to invest on their own into private placements?

Under the current definition, 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 definition is important because it determines which investors are able to make an informed investment decision and protect their own interests in the absence of the protections of the Securities Act of 1933 . Only those investors deemed “accredited” are eligible to participate in private security offerings, such as those conducted in reliance on Rule 506 of Regulation D.

The SEC is required to review the accredited investor definition under the Dodd-Frank Wall Street Reform and Consumer Protection Act. So far, much of the debate has centered on whether the income thresholds should be increased. The current limits were enacted in the 1980s and have not been adjusted for inflation.

In its report, the Investor Advisory Committee raises concerns that the current definition is not sufficiently protecting investors. The group specifically notes that wealth does not necessarily result in financial sophistication and vice-versa.

“While reliance on income and net worth thresholds results in a definition that is clear and relatively simple to implement, this approach over-simplifies the factors that determine whether an individual truly has the wealth and liquidity to shoulder the potential risks of private offers,” the report further states.

Among its recommendations, the Investor Advisory Committee suggests revising the definition to provide other criteria for evaluating an investor’s financial savvy, such as possessing a FINRA Series 7 or other professional credentials. Other proposed approaches include evaluating individuals’ investment experience and/or testing their relevant financial knowledge.

Should the SEC elect to keep the financial thresholds in place, the Investor Advisory Committee suggests restricting the percentage of assets or income that someone can invest in private placements.

“Leaving aside the question of whether the financial thresholds are currently set at an appropriate level, the basic ‘on/off switch’ approach seems illogical,” the IAC argues. “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.”

Given how slowly the SEC has moved on other Dodd-Frank mandates, the accredited investor is unlikely to change anytime soon. However, the latest report highlights that there are many different options on the table, further suggesting that the debate is likely to continue for some time.

If you have any questions about this post or would like to discuss securities regulation, please contact me or the Scarinci Hollenbeck attorney with whom you work.