Will Accredited Investor Criteria Actually Change?

As you may know, to become accredited investors, individuals must meet specific income or net worth requirements as defined in Rule 501 of Regulation D of the Securities Act of 1933. This special status allows accredited investors to participate in many more private placement market offerings that are generally unavailable to non-accredited investors.

Earlier, we discussed reforming the accredited investor standard. Here are some updates to keep in mind:

A recently introduced bill, the Fair Investment Opportunities for Professional Experts Act (H.R. 4762), would expand the definition of "accredited investor" to individuals beyond the criteria. In addition, a recent SEC press release announced proposed amendments to the "accredited investor" and "qualified institutional buyer" definitions noting that these expanded standards would enable even more individuals to participate in private securities offerings.

However, it remains to be seen if the accredited investor criteria will actually change any time soon. In anticipation of this possibility, we hope that the important insights below will help you learn more about these breaking developments and how they may affect you and your options.

Legislative Changes to the Accredited Investor Standard

In October 2019, Congressman French Hill, R-Ark. Introduced H.R.4762 in the House of Representatives. Other than applying the adjusted inflation on the minimum thresholds of $1,000,000 USD net worth and $200,000 USD ($300,000 USD with a spouse) of yearly income, the bill would expand the definition of "accredited investor” to include "an individual who is licensed as a broker or investment advisor by certain entities; and an individual determined by the Securities and Exchange Commission (SEC) to have qualifying education or experience.”

This newly expanded definition means that people with solid expertise in a relevant field or industry would be allowed to invest in certain private placement offerings, regardless of their income or net worth. For example, a doctor may be permitted to invest in a medical startup, and an engineer may be allowed to invest in a high-tech firm, as long as the SEC defines proper qualifying experience or education. If the bill becomes law, these experts, along with certain licensed brokers and advisors, would not be required to meet income or net worth tests for accredited investor status. For all other individuals, the income and net worth requirements would be adjusted for inflation. Time is quickly running out for the bill in the current legislative session, especially considering the fact that it is still in committee and has not yet passed the House.

The current net worth threshold for accredited investor status is assets of at least $1,000,000 USD ignoring the value of their primary residence and after discounting all liabilities (including liabilities exceeding the value of their primary residence and liabilities incurred on their primary residence within the last 60 days); the current income test requires any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

Note that this is not the first time that governmental officials have discussed reforming the accredited investor standard. In 2018, when the Fair Investment Opportunities for Professional Experts Act was included as part of a package of 32 bills called the JOBS and Investor Confidence Act of 2018, which passed in the House by a vote of 406-4. However, the bill, as amended by the House, did not make it to the Senate floor for a vote.

Proposed Amendments to the "Accredited Investor" and "Qualified Institutional Buyer" Definitions

In December 2019, the SEC proposed several changes to the rules that expand the definition of accredited investor and qualified institutional buyer." The proposal would include additional means for individuals to qualify to participate in our private capital markets based on established, clear measures of financial sophistication," said Jay Clayton, SEC chairman, in the press release, dated December 18. 

These proposed amendments to the accredited investor definition would:

• add new categories to the definition that would permit natural persons to qualify as accredited investors based on certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution;

• with respect to investments in a private fund, add a new category based on the person’s status as a “knowledgeable employee” of the fund;

• add limited liability companies that meet certain conditions, registered investment advisers and rural business investment companies (RBICs) to the current list of entities that may qualify as accredited investors;

• add a new category for any entity, including Indian tribes, owning “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;

• add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and

• add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

The SEC’s proposed amendments would allow limited liability companies and RBICs to be included in the “qualified institutional buyer,” category as currently defined in Rule 144A of the Securities Act, as long as they meet the current $100,000,000 USD  threshold in investments and securities. Institutional accredited investors of other entity types using Rule 501(a) may still become qualified institutional buyers by meeting the $100,000,000 USD threshold. 

Should Investor Thresholds Adjust to Inflation?

Currently, the SEC isn’t recommending any investor threshold increases. According to the SEC's analysis, if investor thresholds adjust to match inflation, then significantly fewer individuals would qualify as accredited investors. In fact, the percentage of qualifying households would decrease from about 13% today to about 4% after taking inflation into account.

A 60-day public comment period began on the date the proposal was filed. Interested parties may review or submit their comments online or by emailing rule-comments@sec.gov with File Number S7-25-19 in the subject line. You may also submit comments in writing to:

Vanessa A. Countryman, Secretary

Securities and Exchange Commission

100 F Street, NE

Washington, DC 20549-1090

 

Some Thoughts

Considering the multiple government attempts in recent years to discuss the re-classification of an accredited investor, we believe the definition will eventually change as a result of market demand. The expanded rules and definitions would increase the pool of accredited investors and allow more people than ever to participate in private capital-raising efforts in the U.S. This, in turn, could increase both jobs and entrepreneurial opportunities in the future.

Updated 4/14/23

Becoming an accredited investor can lead to new investment opportunities and can help to increase overall wealth. Although the requirements may seem high, they are put in place to safeguard investors against potential losses. However, the Securities and Exchange Commission (SEC) has added new additions to the accredited investor requirements, allowing individuals with sophisticated financial knowledge or certain connections to qualify without the need for high income or net worth. These new laws were implemented in late 2020:

The License Holders Method allows individuals who hold specific financial licenses, such as Series 7, Series 65, and Series 82, to qualify as an accredited investor. Each license has different requirements, but this new addition is favorable as it enables individuals to qualify based on financial expertise rather than just wealth.

The Insider Method, which was already in place before December 2020, allows directors, executive officers, or general managers of the issuer, or general partners of the issuer's general partner, to become an accredited investor. However, their status is only valid for the particular offering and does not qualify as a general accredited investor status.

The Knowledgeable Employee Method allows a specific list of employees of a firm to engage in the private offering as an accredited investor. Like the Insider Method, this method is also limited to the particular offering. A knowledgeable employee is an executive officer, director, trustee, general partner, advisory board member, or someone serving in a similar capacity of the private fund or an affiliated management person of the private fund, or an employee of the private fund, or an affiliated management person of the private fund, who participates in the investment activities of such private fund, other private funds, or investment companies managed by the affiliated management person of the private fund, provided they have been performing such duties for at least 12 months.

With these new additions to the accredited investor requirements, there are now more ways to qualify as an accredited investor, and it is expected that Rule 506(c) offerings will have a great year in 2023.