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Securities Exchange Commission (SEC) News and Developments on Expanding the Definition of an Accredited Investor

JL Law

Recently the Advisory Committee on Smaller and Emerging Companies to the Securities and Exchange Commission (SEC) voted to recommend that the SEC extend its definition of an accredited investor.

The committee voted to expand the pool of investors eligible to invest in private placement investments, those not registered with the SEC.  The main change was to include everybody who held the Series 7, 65 or 82 securities license exams or who had a chartered financial analyst or similar credential.

A Law is Pending to Change the Definition

Essentially, under the recommendation, the SEC would presume that everybody who held one of those professional-level financial certifications would have the investing knowledge to protect themselves against fraud.

This committee vote is in line with the Fair Investment Opportunities for Professional Experts Act (H. R. 2187) passed by the House of Representatives earlier this year.  Representative David Schweikert, R-Ariz., introduced the bill last year.  It passed the House by a vote of 347 to 8, indicating strong bipartisan support.  It's now under consideration by the Senate.

The Dodd-Frank Act requires the SEC to review how it defines accredited investors who are natural persons every four years. The House felt the SEC was not moving quickly enough to expand the definition, so it introduced its own bill.

The Financial Impact

Experts estimate the private placement market to be around $1 trillion each year.  Even the market for initial public offerings (IPOs) on the stock exchanges has not been that large since 2000, at the peak of the High Tech boom. In 2015, IPOs brought in only $25.2 billion. Click here to see Wilmer Hale’s excellent IPO Report.

However, there aren’t many that qualify as accredited investors.  Estimates vary, but according to DQYDJ using Federal Reserve SCF microdata, only about 8% of Americans qualify for accredited investor status under the current rules. The concept of creating a class of sophisticated investor who did not need as much protection as other investor goes back to the Securities Act of 1933, one of the financial reform laws passed in the wake of the stock market crash of 1929.

The current definition of an accredited investor goes back to 1983.

What are the Accredited Investor Standards?

The rules cover businesses, trusts, charities and other entities. Natural persons generally must:

* Have a net worth, individually or with their spouse, of over $1 million not including their primary residence; or

* Have had income of at least $200,000 (individual) or $300,000 (couple) for the past two years and a reasonable expectation of meeting that same amount in the current calendar year.

Accredited investors own about $45.5 trillion according to DQYDJ. That's about 70.28% of the country's wealth. Although about 8.8 million household qualify on the basis of their net worth, only about 1.3 million qualify on the basis of their incomes.

Laws that require investment by accredited investors make it difficult for small businesses to raise money and for average folks to invest in businesses they might want to support. There are some other ways that non-accredited investors can access private company investments, such as through Title III crowdfunding, but they are generally prohibited from investing in most private placements, hedge funds, venture capital funds, and private capital raises.

Adjusting for Inflation

The SEC Advisory Committee declined to recommend reducing the income and net worth figures defining accredited investors. However, they did vote to adjust those for inflation every five years.

In effect, inflation had substantially increased the pool of accredited investors because the current figures go back to 1983, and the United States has experienced a lot of inflation in the intervening 33 years.

The Jumpstart Our Business Startups (JOBS) Act

Title III of this law allows anyone, including non-accredited investors, to participate in investment offerings through a certain type of crowdfunding.  However, Title III seems destined to fail due to several onerous requirements which make it impractical for most businesses.  While it’s only been legal for a few months, there have been relatively few Title III capital raises even attempted, much less successfully completed.

Title IV of this law allows anyone, including non-accredited investors, to participate in investment offerings through crowdfunding.  However, due to high costs of Title IV and some additional hurdles, it’s adoption has been relatively slow.

Title II of this law, also known as Regulation D, Rule 506(c) crowdfunding, has been the most warmly welcomed form of crowdfunding.  Unfortunately, it doesn’t allow for investment by non-accredited investor.  Nevertheless, accredited investors combine to fund over $1 trillion dollars a year, so that’s still a significant capital source.  If the SEC could expand the current definition of “accredited investors” to include sophisticated parties, that would be winning proposition for everyone.