The SEC is currently examining potential changes to its definition of “accredited investor.” Section 413(b)(2)(A) of the Dodd-Frank Act of 2010 states that the SEC must examine the definition of “accredited investors” under the Securities Act of 1933 every four years to determine whether it should be changed “for the protection of investors, in the public interest and in light of the economy.” This protection is necessary because the investments that are normally offered as private placements consist of higher risk investments such as angel investor networks, hedge funds, limited partnerships, and seed money. Currently, an individual qualifies as an “accredited investor” regarding participation in private offerings of securities under Rule 506 of the Securities Act if the investor has at least $200,000 in annual income in each of the two most recent years or $1 million in net worth without taking primary residence into account.
Unfortunately, the accredited investor qualification is not always followed when brokers offer private placement investments to investors. This is because brokers often receive a very high commission for selling private placement investments. This creates a disincentive to do a background check to see if an investor qualifies for a private placement investment. Often private placement investments are not suitable for investors that do not meet the requirements to be an accredited investor because the investments themselves are inherently risky. The thinking behind the qualifications is that an individual that has a higher net worth or consistently makes a large amount of money every year can more easily take a loss on a risky investment than those that do not qualify.
SEC chair Mary Jo White wrote a letter in November of last year detailing the SEC’s plan regarding the definition, indicating that the SEC is examining
- Whether the existing net worth and income tests are appropriate measures that should continue to be used;
- Whether individuals with certain professional accreditations, including certified public accountants, chartered financial analysts and experienced financial professionals, including registered investment advisors, consultants, brokers, traders, portfolio managers, analysts, compliance staff, legal counsel and regulators should be considered “accredited investors” regardless of whether they satisfy the income and net worth tests;
- Whether individuals with certain educational backgrounds focused on business, economics and finance should be considered “accredited investors” based solely on such backgrounds;
- Whether an expanded pool of “accredited investors” would increase liquidity in private placement investments and thereby reduce the risk profile of those investments;
- Whether reliance on a qualified broker or registered investment advisor should enable ordinary investors to participate in private placements; and
- Whether reducing the pool of “accredited investors” would harm the United States Gross Domestic Product.
White’s letter further indicates that the SEC believes that the inclusion of more financially sophisticated investors in private offerings may improve the extent to which private offerings are generally scrutinized by investors. The SEC is also open to the idea of considering whether certain professional certifications and educational backgrounds could be useful in determining financial sophistication, such as CPA or CFA designations. White, however, stated that concern had already been expressed to the SEC regarding whether academic background in and of itself is an appropriate indicator of “accredited investor” status. The SEC believes that it should complete its review of the “accredited investor” definition by July 2014.