by Cydney Posner
Today, the SEC issued a staff report, required under Dodd-Frank, on the staff’s review of the accredited investor definition. The purpose of the accredited investor concept is to identify, using a bright-line definition, “those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.” The report examines the history of the accredited investor definition and considers various comments received and alternative approaches and recommendations changes for the SEC to consider. Public comments are welcome at the following link on the SEC’s website: http://go.usa.gov/ck8Z7.
The report observes that the individual income threshold has not been adjusted since 1982; the joint income threshold was last adjusted in 1988, and the net worth threshold has been revised since 1982 only once — to exclude the value of a person’s residence. However, inflation has affected these thresholds considerably. For example, an inflation-adjusted threshold for individual income would be more than twice as high as the current $200,000 (ranging from $432,000 to $491,000), and the percentage of investors that qualify on that basis has also increased substantially, from 0.5% to 6.6%. Overall, “the 1.51 million households qualifying in 1983 represented approximately 1.8% of U.S. households, while the 12.38 million qualifying in 2013 represented approximately 10.1% of U.S. households.” The report notes that a number of commenters recommend adjustments to the income and net worth thresholds, ranging from changing the thresholds (e.g., by raising the income thresholds or excluding retirement assets from net worth) to implementing revised or alternative financial criteria (such as limiting investments to a percentage of net worth, looking at the level of investments owned or considering investors’ education, profession, investing experience, relationships with issuers, use of financial intermediaries and financial expertise). Other approaches suggested include using sliding scales, contextual evaluation of an investor’s attributes and a layered approach with different thresholds.
With regard to investor-entities, the report maintains that the “principal limitations with the current accredited investor framework for entities are that some types of entities are not accredited investors because the definition does not specifically include them, and that the definition does not provide flexibility for legal developments…. Making the definition applicable to all types of entities, however, could result in entities without access to sufficient information and lacking the financial sophistication needed to conduct meaningful investment analysis becoming accredited investors. Expanding the definition in that manner would require careful consideration of whether the existing asset-based test identifies those entities that do not need the protections of registration.” Previous comments suggested that a “revised accredited investor definition for entities that includes a catch-all provision and an investments-owned test may more effectively measure financial sophistication than the current definition…”
The report also provides these staff recommendations for the SEC to consider:
“The Commission should revise the financial thresholds requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify as accredited investors. The Commission could consider the following approaches to address concerns with how the current definition identifies accredited investor natural persons and entities:
- Leave the current income and net worth thresholds in place, subject to investment limitations.
- Create new, additional inflation-adjusted income and net worth thresholds that are not subject to 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.
- Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.
The Commission should revise the accredited investor definition to allow individuals to qualify as accredited investors based on other measures of sophistication. The Commission could consider the following approaches to identify individuals who could qualify as accredited investors based on criteria other than income and net worth
- 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.”