On December 18, 2015, the SEC staff issued a report regarding its first review of the accredited investor definition under the Dodd-Frank Act, which requires review of the definition every four years. The report, prepared by staff from the Divisions of Corporation Finance and Economic Risk and Analysis, examines the history of the definition, considers comments received from a variety of sources, analyzes the impact of potential approaches, and provides staff recommendations for the SEC to consider. Members of the public may comment here.
Accredited investors may participate in investment opportunities that are generally not available to non-accredited investors, such as investments in private companies, hedge funds, private equity funds, and venture capital funds. This qualification has become of increased significance with the introduction of the JOBS Act, crowdfunding sites such as AngelList, and the overall growth of the private placement market. The accredited investor definition “attempts to identify those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.” An objective of the definition is to create bight-line tests that are easy to understand and administer.
The report notes the difficulty in striking a balance between capital formation and investor protection. For instance, the current hard line economic rule makes the definition easy to manage, but it can be under-inclusive, as it places no relevance on education, sophistication or professional experience. On the other hand, the income and net worth thresholds have remained constant since 1982 (1988 for the joint income threshold) without any adjustment for inflation, so the percentage of individuals that qualify on that basis has increased substantially. The report recommends a path to accreditation based on improved financial thresholds and the consideration of other factors.
Below is a summary of the staff recommendations, taken directly from the report:
- The Commission should revise the financial thresholds requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify as accredited investors.The Commission could consider the following approaches to address concerns with how the current definition identifies accredited investor natural persons and entities:
- Leave the current income and net worth thresholds in place, subject to investment limitations.
- Create new, additional inflation-adjusted income and net worth thresholds that are not subject to investment limitations.
- Index all financial thresholds for inflation on a going-forward basis.
- Permit spousal equivalents to pool their finances for purposes of qualifying as accredited investors.
- Revise the definition as it applies to entities by replacing the $5 million assets test with a $5 million investments test and including all entities rather than specifically enumerated types of entities.
- Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.
- The Commission should revise the accredited investor definition to allow individuals to qualify as accredited investors based on other measures of sophistication.The Commission could consider the following approaches to identify individuals who could qualify as accredited investors based on criteria other than income and net worth:
- Permit individuals with a minimum amount of investments to qualify as accredited investors.
- Permit individuals with certain professional credentials to qualify as accredited investors.
- Permit individuals with experience investing in exempt offerings to qualify as accredited investors.
- Permit knowledgeable employees of private funds to qualify as accredited investors for investments in their employer’s funds.
- Permit individuals who pass an accredited investor examination to qualify as accredited investors.