Last week, the SEC’s Investor Advisory Committee met to, among other things, consider revisions to the definition of “accredited investor” under the Securities Act of 1933, as required by the Dodd-Frank Act. Under the current test, adopted in 2010 when the Dodd-Frank Act was enacted, an individual is considered to be an “accredited investor” if he or she has at least $200,000 in annual income in each of the two most recent years ($300,000 for married couples) or $1 million in net worth, excluding the investor’s primary residence.
In Europe, the notion of “accredited investor” does not exist, but applicable EU legislation has a somewhat approaching notion. The Markets in Financial Instruments Directive (MiFID – Directive 2014/65/EU of the European Parliament and of the Council of May 15, 2014 on markets in financial instruments) adopts two main categories of clients: retail and professional. There is a separate and distinct third category that covers a limited range of business: eligible counterparty (ECP). Different levels of regulatory protection attach to each category and hence to clients within each category.
Retail clients are afforded the most regulatory protection.
Professional clients are considered to be more experienced, knowledgeable and sophisticated and are as such able to assess their own risk and are afforded fewer regulatory protections.
ECP are investment firms, credit institutions, insurance companies, collective investment funds (UCITS) and their management companies, other regulated financial institutions, and in certain cases, other undertakings. MiFID provides a ‘light-touch’ regulatory regime when investment firms bring about or enter into transactions with ECPs.
Any clients not falling within the list of entities qualifying as professional clients are, by default, retail clients. Under MiFID, there is a potential for certain clients to be treated as falling into a different category i.e. to increasing or decreasing the levels of regulatory protection afforded. Retail clients can request treatment as professional clients by stating in writing that they wish to be treated as a professional client. Also, the client, may, in a document separate from the contract, state that he or she is aware of the consequences of waiving the retail protections.
Under MiFID, investment firms must take reasonable care to ensure that a retail client requesting treatment as an ‘elective’ professional client is able to meet the ‘qualitative’ criteria and, as part of these criteria, a separate ‘quantitative’ test. The qualitative assessment requires the firm to undertake ‘an adequate assessment’ of the expertise, experience and knowledge of the client to give ‘reasonable assurance’, in the light of the nature of transactions or services envisaged, and acknowledge that the client is capable of making his or her own investment decisions and ’understand the risks involved’. In assessing the client’s expertise, experience and knowledge, the client must satisfy at least two of the following quantitative criteria:
the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters;
the size of the client’s financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds EUR 500,000;
the client works or has worked in the financial sector for at least one year in a professional position which requires knowledge of the transactions or services envisaged.
Applicable to the provision of other financial services under MiFID, the definition of professional clients is also used in connection with offerings of financial instruments within the EU as a result of the revision in 2010 of the Prospectus Directive (pursuant to Directive 2010/73/EU of the European Parliament and of the Council of November 24, 2010 amending Directives 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to trading and 2004/109/EC on the harmonization of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market). A prospectus is not required for an offer of securities addressed solely to qualified investors, now defined as professional clients and ECPs, the rationale beyond this change being to reduce the complexities and costs for investment firms in the event of private placements, because the firms would be able to rely on the list of professional clients and eligible counterparties drawn up in accordance with MiFID and no separate regime for registers should be maintained. With higher requirements, the EU regime seems more protective of its high net worth investing base than the US one. One thing the SEC’s Investor Advisory Committee may want to have in mind in considering revisions to the accredited investor definition.