26 Aug Flash: SEC Expands Accredited Investor Definition

After years of endless discussion, the Securities and Exchange Commission just announced an expansion of the definition of “accredited investor” under SEC rules and Regulation D in particular. Many companies, both public and private, who seek private investments limit their offering to accrediteds primarily because of reduced disclosure obligations and no limit on the number of these investors. In addition, to take advantage of certain Reg D sections such as Rule 506(c), all investors must be accredited. The important amendments to the accredited investor definition in Rule 501(a) are:

• Add a new category to the definition that qualifies you as accredited because of some professional certification, designation or credential. They can add more later, and have requested suggestions, but for now they are saying that those with certain securities licenses will now be deemed accredited;
• Include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
• add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
• add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

What didn’t they do? Several Democrat Commissioners issued a “dissent” to the new rules. As we know, individuals are accredited if they have income in excess of $200,000 (or $300,000 with their spouse) or a $1 million net worth excluding one’s primary residence. The theory? You are either rich and smart and can protect yourself, or you are rich and dumb and can afford someone to advise you. These thresholds were set in 1982, and after inflation the $200,000 arguably should be over $500,000 to be equivalent today. There was pressure from investor protection groups either to raise the income and net worth thresholds or at least index the minimum to inflation going forward. The SEC chose to do neither and the dissenters expressed frustration about that. The release noted there was no information about what factors the SEC of 1982 considered in setting the financial thresholds.

My initial take on this: focusing accredited status more on sophistication vs. income or wealth makes sense.  For example, CPAs probably should be automatically accredited as they have presumed sophistication about financial matters. As one SEC commissioner wrote, why not let SEC examiners be accredited? They literally review and approve offering documents, but do not make enough to be accredited. Yet they were not included. There was also talk of allowing investors to take a government-administered test to confirm knowledge of finance. I once asked a senior SEC official if lawyers should be accredited. His response: Do you really believe that all lawyers are sophisticated? My response: Good point. I may have more to say after reading the 166-page SEC release.