The Growing Number of Accredited Investors in the U.S.

Why is the Definition of “Accredited Investor” Important?

In the U.S., not just anyone can invest in unregistered securities. 

To participate in many private equity opportunities, such as venture capital, hedge funds, or pre-IPOs (Initial Public Offering), an individual or entity must qualify as an “accredited investor.” 

As the primary federal regulatory agency responsible for securities, the Securities and Exchange Commission (SEC) determines who qualifies as an “accredited investor.”  

Investors who meet the SEC’s definition of “accredited investor” are eligible to participate in “exempt” offerings — i.e., securities offerings that come within an exemption under the Securities Act of 1933. 

The definition of “accredited investor” is what determines who may and who may not participate in certain investment opportunities. The definition of “accredited investor” is “a cornerstone of Regulation D” — one of the most widely used securities exemptions issuers rely on to raise capital. Plus, it is pivotal to a variety of other federal and state securities laws.  

That makes the definition of “accredited investor” a seminal one.

So, …

Who Can Be an Accredited Investor?

Accredited investors can be individuals or entities. 

For individuals, under Rule 501(a) of the Securities Act, to qualify as an accredited investor, the individual must:

• have an earned income that exceeded $200,000 USD in each of two prior years (or $300,000 USD if qualifying with a spouse or spousal equivalent), and the individual must reasonably expect that income to continue for the current year, or

• have a net worth of over $1 million USD (excluding the value of a primary residence) either individually or with a spouse/spousal equivalent, or

• hold a Series 7, 82, or 65 professional license in good standing, or

• qualify as a “knowledgeable employee” under Rule 3c-5(a)(4) of the Investment Company Act of 1940, or 

• qualify as “family clients” under Rule 501(a)(13). 

Entities can also qualify as accredited investors. For example,

• trusts with assets in excess of $5 million USD (that also meet certain other criteria), 

• entities where all equity owners are accredited investors, or 

• entities that have investments of over $5 million USD and are not formed for the sale of the subject securities, 

How Did the Current Definition of Accredited Investor Come About?

Without getting too far into the securities law weeds here, defining who qualifies as an “accredited investor” began — and has grown over time — as a means of allowing issuers to reliably identify investors they can sell unregistered or private securities to while remaining in compliance with the securities laws. It also helps the SEC balance its competing duties of protecting investors while at the same time promoting capital raising for small businesses.

By providing a monetary threshold to define who is and who is not an “accredited investor,” the SEC has attempted to draw a line that identifies which investors are sophisticated enough to understand the risks involved in investing (i.e., can “fend for themselves”) and can sustain the risk of loss of an investment. The rationale for this approach has been that those with a higher net worth or income do not need the protections that securities registration affords investors (generally in the form of disclosures). 

The problem with this approach is — and the main criticism of it over the years has been — that it equates financial wealth with “sophistication.” Opponents of the SEC’s definition argue that just because someone is wealthy does not mean they are “sophisticated” when it comes to investments. See, for example, lottery winners. The reverse is also argued: that the lack of a specific dollar amount in income does not necessarily reflect one’s financial sophistication or understanding of investments.

Nevertheless, the SEC’s definition has remained grounded in net worth and individual wealth metrics. With two exceptions, —  the 2010 amendment excluding a personal residence from the calculation and the 2020 amendment allowing for professional certifications and “knowledgeable employees” to qualify as accredited investors — the SEC’s definition of “accredited investor” has remained largely unchanged since 1982.  

When it was first implemented over 40 years ago, not many Americans qualified as “accredited investors.”

That, however, has changed.  

The Number of Accredited Investors Has Risen Steadily and is Still Growing.

According to recent reports, the number of American households qualifying as accredited investors has reached an all-time high. 

In its December 14, 2023 Review of the “Accredited Investor” Definition under the Dodd-Frank Act (“SEC Report”), the SEC states that the number of accredited investors has grown significantly over the years. The SEC Report details with charts and graphs, how, over the four decades since the definition was first adopted, the number of households qualifying for accredited investor status jumped from 1.8% in 1983 to more than 18% in 2022.

Whereas only the top 1% to 2% of households achieved “accredited investor” status in 1983, by 2019, 16 million households — or 13% attained that status. 

Although it may be encouraging to know that more people can now qualify as accredited investors for purposes of private investments, such a vast number of investors raises some questions regarding the adequacy of financial literacy and risk awareness among new entrants.

So, how did we get here?

Let’s see what influenced the growth of accredited investors over the years and what the ramifications of that growth may portend.

What Has Caused the Growth in the Number of Accredited Investors? 

According to the SEC Report, there are several reasons for the growth in the number of accredited investors over the years.

First, the SEC believes that the number of accredited investors has grown steadily in the 40 years since the definition was adopted because it has not been adjusted to reflect inflation. 

If, says the SEC, the definition had been tied to inflation, then from the time of its initial adoption through to 2022:

• the net worth threshold for an individual would have increased from $1 million to $3,037,840, and

• individual income required would have increased from $200,000 to $607,568, and 

• the threshold for joint income would have increased from $300,000 to $911,352.

Next, the SEC Report indicates that amendments to the definition in 2020, which expanded the definition to include qualification based on professional knowledge, experience, or certifications, also expanded the number of investors who could qualify as accredited.

Finally, the SEC believes that a change in investor assets for most American households in the past 40 years has increased the number of households qualifying for accredited investor status. In particular, the SEC points out that over the years, more households have acquired retirement savings — adding to their net worth. This was not the case in 1982 when the definition was first adopted. Retirement savings now make up a solid portion of a household’s wealth. The growth in retirement savings — and the fact that many people direct their own retirement accounts — appears to be responsible for a significant increase in households that can qualify as accredited investors. In particular, points out the SEC, in 1982, the number of defined benefit plans in the private sector had 29.7 million active participants and the private sector only had 23.4 million. However, by 2020, there were only 12 million active participants in the private sector defined benefit plan and 85.3 million active participants in defined contribution plans.

Over time, these factors all have led to an increase in the number of households able to qualify as “accredited investors” according to the SEC’s current definition of that term, which, as noted, is not indexed to inflation.

If the “accredited investor” definition remains un-indexed to inflation, the SEC estimates that by 2032, the number of households qualifying as accredited investors will rise to 45.8 million — or approximately 31.4%.

Potential Benefits and Risks for Investors of Having More Accredited Investors  

While having more accredited investors may sound great, there are risks as well as benefits to the increase in the number of accredited investors.

Let’s start with the benefits first. 

Having more accredited investors is good for both investors and issuers. For issuers, the increase in the number of accredited investors means that there are more investors available to participate in private equity deals — giving issuers a larger pool of investors to work with. For investors, it portends more opportunity and greater democratization of investments, as the ability to qualify as an accredited investor is open to more individuals across more economic levels.

So, what are the risks of having more investors? 

Well, one problem espoused by investor advocates is that because the accredited investor thresholds haven’t been indexed to inflation for over four decades, it makes it much easier for more people to qualify. This, in turn, allows some middle-class individuals into the investing world who may not have the financial reserves or experience necessary for participating in private equity investments. (Exactly, one might say, what the SEC was trying to prevent with its definition of “accredited investor” in the first place.) Because wealth does not equate to financial sophistication, the fact that so many more households now qualify for the $1 million threshold, it is argued that the current definition of “accredited investor” is no longer particularly effective at protecting unsophisticated investors. 

This dilution of the protections afforded by the current definition of accredited investor is something the SEC is aware of. However, although they have considered whether or not to index the definition to inflation (thus tightening the requirements and reducing the investor pool), and are still looking into it, so far, the SEC has not yet changed its policies to index the investor thresholds to inflation. 

While the SEC recognizes that the current definition of “accredited investor” — even as amended — is not perfect, really does not reflect one’s financial sophistication, and is causing the number of households that qualify for accredited investor status to grow significantly, for now, the SEC is sticking with it.

Ensuring Proper Verification of Accredited Investors is as Critical as Ever.

With the rise in the number of accredited investors, compliance for issuers is critical. Although having more accredited investors may make it slightly easier to find accredited investors, because the accredited investor definition may no longer be effective at protecting investors, issuers need to be vigilant about verifying accredited investors. Using a reliable third-party investor verification service is a smart thing for both issuers and investors to do. Investors can obtain an accredited investor certificate to prove their qualifications, and issuers can participate in a complete investor accreditation program.

The securities laws touch on a vast number of financial and investment issues of importance to investors and issuers alike. VerifyInvestor.com makes verifying accredited investors easy, cost-effective, secure, and reliable. Our services, (which also include AML/KYC, qualified purchaser, and qualified client verification), are always code-compliant and confidential. We help companies fully and easily comply with their legal obligations to verify accredited investors.