The Securities and Exchange Commission recently met to discuss and hash out whether it should revise the standards that define an “accredited investor”.  Broker dealers have been concerned that changing the definition to this rule could narrow the pool of investors that would meet the definition, and thus narrow the market for products that have an accredited investor requirement.  Such products usually involve investments in upstart companies or risky ventures with little to no certainty of the future predictability of the investment. These investments are usually know as private placements.  These investments do not need to be registered with the Securities and Exchange Commission because they are normally offered to only a few individuals or companies.  Normally there is not detailed information, financial or otherwise, about the investment and often the fund will request investors waive the need for a prospectus.

Under the current definition, to qualify as an accredited investor one must either have a net worth, not including one’s primary residence, of a least $1 million; or have an income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

The SEC made several recommendations for the new accredited investor definition which included:

–          Evaluating whether it is a meaningful and proper way to effectively identify those that would need the protections supplied by the Securities Act, questioning specifically whether the current financial thresholds based on income and net worth are good markings for those that are able to understand and be exposed to the risks that are usually inherent of private placement investments.

–          Create additional protective rules if the Commission determines that the current definition allows individuals to qualify that are not sophisticated enough to be involved with those investments.

–          Revise the definition to consider actual investment sophistication and knowledge rather than mere threshold net worth and income stream requirements.  This would allow investors with the knowledge to invest in private placements to do so without being barred by the potentially arbitrary current requirements.

–          To evaluate limits on the amounts an individual could place in private placements based on threshold net worth and income stream requirements in order to protect investors but also allow them to be exposed to a certain amount of risk if they so desire.

–          Create a third party that would be able to identify if an investor would qualify since broker dealers do not always perform an adequate job of this and thus may expose investors to risks that they are not qualified to bear.

–          To increase the protections that are afforded to non-accredited investors that are allowed to participate in private placements on the advice and help of a broker or financial representative in order to shield those investors from the dangers and potential harms of these riskier investments.

The SEC has clearly communicated it is concerned about the protections afforded to those that participate in these investments and is encouraging brokers and their broker dealers to ensure their customers are adequately placed in these investments.

To learn more about Richard Frankowski visit The Frankowski Firm.