United States: SEC Report Examines Potential Changes To The ‘Accredited Investor' Definition

On Dec. 18, 2015, the Securities and Exchange Commission (the "SEC") released a staff report on its review of the definition of "accredited investor" as set forth under Regulation D of the Securities Act of 1933, as amended (the "Securities Act"). The staff issued the report in accordance with a Dodd-Frank Wall Street Reform and Consumer Protection Act requirement to determine whether the definition — as it applies to natural persons — should be modified or adjusted for the protection of investors, in the public interest and in light of the economy. In the interest of providing a comprehensive analysis, the staff report also addresses the use of the "accredited investor" definition as it applies to entities.

The "accredited investor" definition is central to the transactional exemptions set forth under Regulation D of the Securities Act. The Regulation D exemptions allow issuers to offer securities to certain sophisticated investors without having to register such securities with the SEC as is generally required under the Securities Act. Investors that qualify as "accredited investors" under Regulation D are eligible to participate in investment opportunities unavailable to other, less sophisticated investors. The "accredited investor" definition also plays an important role in other federal and state securities law contexts.

Under the existing definition, a natural person is an accredited investor if his or her (i) income exceeds $200,000 (or $300,000 in joint income with a spouse) in each of the two most recent years and is reasonably expected to do the same in the current year or (ii) net worth exceeds $1 million, either individually or jointly with a spouse (excluding the value of their primary residence). Banks, partnerships, corporations, nonprofits and trusts may also be eligible for accredited investor status if they fall into one or more category of investors as enumerated under Regulation D.

The staff recommends that the SEC revise the definition of "accredited investor" to amend or modify (i) the financial thresholds requirements for natural persons in order to adjust for inflation since the dates on which the existing financial thresholds were established and (ii) the list-based qualification approach for entities in order to permit otherwise eligible entities that do not fall within an enumerated category of "accredited investor" to nonetheless qualify as accredited investors. In particular, the staff recommends that the SEC consider the following approaches:

  • Leave the current income and net worth thresholds in place, subject to investment limitations;
  • Establish new, inflation-adjusted income and net worth thresholds without 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; and
  • Grandfather issuers' existing investors that are accredited investors under the current definition with respect to future offerings of their securities.

The staff also recommends that the SEC revise the "accredited investor" definition to establish measures of sophistication outside of the bright-line income and net worth tests currently in place that would (i) permit certain knowledgeable investors that do not meet existing financial thresholds requirements to participate in investments available only to accredited investors and (ii) preclude wealthy investors unable to understand certain risks associated with an investment from participating in such investment. The staff recommends that the SEC consider the following approaches to address what it calls the "under- and over-inclusive" nature of the existing quantitative criteria:

  • 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; and
  • Permit individuals who pass an accredited investor examination to qualify as accredited investors.

The possible effects of these proposed changes are as varied as the recommendations themselves. For example, should the SEC raise the existing income and/or net worth thresholds, the number of qualifying households would "shrink considerably."

Alternatively, should the SEC permit individuals with a minimum amount of investments to qualify as accredited investors, the number of eligible households would increase.

The SEC has requested public comment on the staff report, but did not stipulate a deadline for those interested in providing feedback.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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