The Debate over the SEC’s Proposed Increase of the Wealth Threshold Requirements of the Accredited Investor Definition

It’s no surprise that investors and regulators don’t always see eye to eye. One major point of contention that continues to spark debate is the Securities and Exchange Commission’s (SEC) definition of “accredited investor.” This issue heated up again recently due to the SEC’s April 2023 proposed increase in the wealth threshold requirements for the “accredited investor” definition.

Not so long ago the SEC broadened the definition of accredited investor to include, among other categories, “knowledgeable employees” and “family offices.” By expanding the definition of accredited investor in this way, the SEC widened the investment opportunities for individuals and entities looking to invest in private equity deals.

During the debates over the SEC’s 2020 changes to expand the definition of “accredited investor” to include new categories of individuals, the fact that wealth alone is not the only or even the most valid, indicator of a person’s investment sophistication, was stressed by regulators and investors alike.   

The 2020 amendments to the SEC’s definition of “accredited investor” enabled potential investors to qualify as an accredited investor based not only on income or net worth but upon defined measurements of professional knowledge, experience, or certifications — expanding the number of investors who can participate in private equity while at the same time carrying out the SEC’s mission to protect investors. 

This time, however, the SEC’s proposed changes will move the needle in the opposite direction. 

According to reports, the SEC will be changing the definition of “accredited investor” to increase the wealth threshold requirements that must be met for individuals or entities to qualify as an accredited investor. 

As we will discuss in more detail below, critics say that this will severely limit who may receive an accredited investor status certificate, narrowing the field of potential investors and making it harder for companies trying to raise capital to figure out how to find and verify accredited investors. 

The Current Definition of “Accredited Investor.”

The Securities Act of 1933 (“Securities Act” or “the Act”) requires that every public offering of a security be registered with the SEC. Registering securities with the SEC protects investors, but it is a burdensome, time-consuming, and expensive process for businesses. As a result, over the years, the SEC developed some exceptions to the rule in order to ease the regulatory burden that registration places on small businesses.

Most notably, private placements under Regulation D (“Reg. D”) are not required to comply with the SEC’s comprehensive public disclosure requirements that apply to registered offerings. For investors, this means that they can participate in private offerings — SO LONG AS — the investor is either an “accredited investor” or the number of non-accredited investors is limited to 35 (see, Reg. D 506(c).). 

The SEC’s definition of “accredited investor” contains both net worth and income requirements to protect investors from fraud. It also includes other indices of financial sophistication. For the most part, the SEC’s definition of “accredited investor” hasn’t changed significantly since 1982. 

The current wealth threshold for its definition of “accredited investor,” found in Rule 501 of Reg. D, requires that an individual be able to show that in the most recent two-year period he or she individually had an income in excess of $200,000 or a net worth (excluding a primary residence) of over $1 million. Alternatively, an investor can qualify if he or she had a joint income (in the past 2 years) with his/her spouse (or spousal equivalent) in excess of $300,000, and he/she has a reasonable expectation of reaching that same income level in the upcoming year. 

Regarding the indices of sophistication, in 2020, the SEC broadened the definition of accredited investor to include: 

• knowledgeable employees,

• registered investment advisors, exempt reporting advisers, and rural business investment companies, 

• a catch-all provision for entities that own more than $50 million, and

• family offices and family clients.

One of the major advantages of being an “accredited investor” is that it opens up investing opportunities that are not available to non-accredited investors. For example, while non-accredited investors can invest in mutual funds unless an offering meets an exemption, non-accredited investors either cannot participate at all, or only 35 non-accredited investors can participate, in a private equity offering.

By changing the definition of “accredited investor” to include more individuals with sophisticated investment experience, the SEC broadened investing to reach more investors. At the same time, however, the SEC required that issuers offering Reg. D securities verify accredited investor status for each one of their investors.  

Increasing the Accredited Investor Wealth Threshold, Decreasing the Number of Accredited Investors.

Having expanded the indices of sophistication in 2020, thus allowing more people to participate in investing, the SEC’s proposed 2023 changes to the definition of accredited investor will raise the required wealth threshold. 

This latest proposed expansion of the definition of “accredited investor” is causing quite a stir in the investment community.

Under Chairman Gary Gensler, the SEC intends to amend “the accredited investor definition by increasing the annual income and net worth thresholds.”

What dollar amount the wealth threshold will increase to has not been announced yet by the SEC. However, according to some reports, it is possible that the SEC might link the wealth metric to inflation. If that does happen, it is believed that the threshold requirement could triple — drastically diminishing the pool of accredited investors. 

Opponents of the SEC’s proposed reforms to Regulation D (“Reg. D”), including increasing the wealth threshold for “accredited investors,” argue that these reforms will increase costs, complexity, and liability exposure of companies attempting to raise capital under the Reg. D exemptions. 

Angel investors posit that the proposed changes will severely reduce the number of wealthy individuals who can participate in investment opportunities. This, they say, will have a national effect that would be devastating to start-ups that rely on angel investors to raise capital, because the increased wealth thresholds will reduce the pool of angel investors able to meet the new thresholds. 

Other arguments are that the SEC’s changes will unfairly limit access to those who do not have excessive wealth, thereby increasing a lack of diversity in investing. Many object to the SEC’s proposals as being overly paternalistic and interfering with an individual’s right to decide for himself/herself whether to invest or not. 

Opponents of the change point out that Rule 506(b) and the less frequently used 506(c), play a significant role in raising capital for small businesses. According to reports, between July 1, 2021 and June 30, 2022, Rule 506(b) offerings raised more money than all registered offerings ($2.3 trillion), while even the less used Rule 506(c) offerings raised more money than IPOs.  

And yet, despite this significant impact, the SEC’s current wealth threshold, as expressed in its current definition of “accredited investor,” already prevents over 90% of American households from participating in these offerings. 

Increasing that threshold even further, opponents argue, will serve only to increase that gap. In addition, opponents point out that being wealthy is not the same as being “financially sophisticated.” Lottery winners have money, but that does not mean that they are “financially sophisticated” or are experienced investors. Nevertheless, the SEC’s new proposed changes would allow financially unsophisticated investors to participate in riskier private offerings, while eliminating experienced but less wealthy investors from doing so. Given all this, opponents say that the SEC’s definition of “accredited investor” is flawed because it places more emphasis on how much money a person has rather than how much education or investment experience he or she has. 

In defense of the change, U.S. Securities and Exchange Commission (SEC) Commissioner Caroline Crenshaw indicated in a recent talk that Reg. D was intended as a limited exception but over time, it has gotten out of hand. 

From the SEC’s point of view, a number of reforms are necessary to protect investors. 

According to the SEC Commissioner, over the years, the use of Reg. D has caused a “bloating effect” on private issuers — allowing private companies to raise billions of dollars to fund their growth without the regulatory oversight necessary to protect investors. The concern is that the lack of information about private businesses and the minimal regulatory oversight makes private equity investments riskier for investors — putting even sophisticated investors at a disadvantage. Increasing the wealth threshold, according to the SEC, will protect the vast number of investors from being in a situation where they receive little to no disclosures. 

According to the SEC Commissioner, financial sophistication does not adequately protect investors in the same way that disclosures and regulatory oversight do.  

Changes Are Coming. 

Whichever side of the debate you land on, one thing is for sure: you can expect to see some changes in the near future to the SEC’s definition of “accredited investor.” 

While the emphasis for accredited investor criteria has always included an income test and a certain level of wealth, both sides of the debate have indicated that it’s not only about how much money a person has — there should be some more definitive way of assessing an individual’s investment experience, knowledge, and sophistication. 

In the meantime, accredited investors and issuers can rely on VerifyInvestor.com for accredited investor status verification. At VerifyInvestor.com, we offer a world-class accredited investor verification service. Our services are fast, efficient, cost-effective, confidential, and reliable. We help companies fully and easily comply with their legal obligations to verify investors as accredited investors.