Defining 'accredited investor': Data required
Recently, a number of members of the SEC’s Investor Advisory Committee (IAC) expressed their view that more data is needed before the agency can update the definition of “accredited investor.” During a July 10 meeting (Webcast), the IAC discussed whether proposed changes would enhance investor protection in the private offering marketplace. The driver for the meeting was a Dodd-Frank mandate that the commission review the definition every four years. Investors who are considered accredited, and therefore presumed to be sophisticated enough to protect themselves, may invest in private securities offerings that are not formally registered with the SEC.
The current dollar thresholds used to determine whether an investor is accredited have largely remained constant since 1982, except for a notable change in 2011 that excluded the value of a primary residence when determining an individual’s net worth. Under the current definition, a person making at least $200,000 a year ($300,000 for couples) over the last two years, or with an individual or joint net worth that exceeds $1 million (excluding a primary residence) are deemed accredited.
In 2012, Congress passed the Jumpstart Our Business Startups (JOBS) Act, which lifted the ban on general solicitation of private securities offerings made under the SEC’s newly created Rule 506(c). This provision allows issuers to effectively market their offerings to investors and raise an unlimited amount of capital from them, provided that issuers verify the accredited status of the investor. As a result, the definition of accredited investor is influencing the potential size of the Rule 506(c) market as issuers seek to tap larger pools of capital.
Some proposals would broaden the definition, others would narrow it. Some experts have suggested adopting caps akin to those proposed by Regulation Crowdfunding, whereby an investor would be limited in making annual Rule 506(c) investments based on a preset percentage of income or wealth. Others have urged the SEC to revise Form D filing requirements to collect additional information on private offerings with the goal of better understanding the marketplace.
Following is a nonexhaustive list of proposed changes to the definition:
- Increasing the dollar thresholds for the income and wealth tests: If they were set to increase at the rate of inflation, the new income threshold would be $400,000 and the wealth threshold $2.5 million.
- Changing the net-worth test to exclude certain assets such as retirement accounts or illiquid land holdings.
- Creating a means to test investors’ sophistication that would allow those who are knowledgeable enough to participate in private markets.
- Adoption of an “investment owned” test based on the dollar amount and type of securities owned.
- Adopting knowledge and/or experience-based standards that would allow private market participation, including requiring the individual to hold:
- An advanced education degree
- A professional designation or
- A securities license(s)
- Allowing participation if the individual transacts through a registered investment advisor or broker-dealer.
Notwithstanding these proposals, some IAC members urged caution in overhauling the definition without better data on private offerings and the potential impact of a definitional change on the private marketplace.
The Milken Institute Center for Financial Markets will continue to explore developments related to use of Rule 506(c) general solicitation through online investment platforms, and how such developments should inform the SEC’s review of the definition of “accredited investor.” The national discussion surrounding the definition is at least in part impacted by the SEC’s lifting of the ban on general solicitation of private offerings ten months ago as required by the JOBS Act, which has allowed time for the marketplace to develop before the Commission decides on any definitional changes. Through our work, we will analyze marketplace data and developments, consider factors impeding the growth of the market, and discuss related insights relevant for policymakers.