The Securities Act of 1933, passed in the depths of the Great Depression, requires that the Securities and Exchange Commission (SEC) register the sale and offerings of securities.
There are exemptions to the Securities Act, and these include bestowing accredited investor status on those whose “financial sophistication” enabled them to sustain risks of loss so that SEC registration was unnecessary.
The SEC permits such accredited investors, whether individuals or businesses, to invest in areas outside the purview of non-accredited investors.
These investors have the opportunity to invest in private equity, private investing, venture capital, angel investing, equity crowdfunding, and hedge funds, all of which are outside of the realm of the ordinary investor. These are complicated investments, requiring in-depth knowledge of finance.
If you're interested in these asset classes, you'll need to be an accredited investor. This article explains what it takes to be an accredited investor.
Accredited Investor Categories
As per Regulation D §230.501 of the Code of Federal Regulations, an accredited investor is someone who fits into one of several categories. The regulation notes the issuer “reasonably believes” the person is included within the permitted categories when the securities are sold. Accredited investors include:
- Banks
- Savings and loan associations
- Insurance companies
- Broker/dealers
- Employer-sponsored retirement plans
- Trusts
- Natural persons meeting net worth eligibility
- Entities consisting entirely of accredited investors as equity owners.
Accredited Investors and Net Worth
Accredited investors must prove themselves financially sophisticated people. Potential accredited investors includes those whose net worth exceeds $1 million, held individually or jointly with a spouse. The primary residence is not included in the minimum net worth figure. Mortgage or other debt on the residence is not considered a liability, as long as the loan does not exceed the home’s fair market value. If the mortgage is underwater, or higher than the fair market value, the amount over the home’s value is deducted from the net worth amount.
If someone does not meet the minimum net worth amount but had an individual income of more than $200,000 in each of the two prior years, they may qualify as an accredited investor. The same holds true for that individual’s spouse if the couple made over $300,000 in those years and expects they will maintain that income level in the present year.
Trusts may qualify if they hold at least $5 million in assets. Another caveat –such trusts cannot have been created specifically to buy the securities in question. Again, financial acumen is critical, as only a sophisticated investor may guide such purchases.
Partnerships, corporations and charitable organizations with over $5 million in assets may receive accredited investor status.
Becoming an Accredited Investor
No formal process exists by which you can become an accredited investor. There is no test to take or certification granting this status. If you meet the financial standards, you must provide documentation to the firm selling unregistered securities in the form of income tax returns, financial statements, W-2 forms, and a credit report. Businesses must include balance sheets. It is the firm itself that determines whether you are an accredited investor under SEC guidelines.
Accredited Investor History
Regulation D went into effect back in 1982, and little has changed in the nearly 40 years since. The past four decades have seen a significant rise in inflation, but the financial criteria for becoming an accredited investor is the same as it was back then.
In late 2015, the SEC released a report concerning accredited investor definition review. After all this time, it finally appears actions are going forward on updating accredited investor metrics.
Improving the Definition
In December, 2019, the SEC voted to amend the definition of accredited investor. The proposed changes go beyond net worth or income as a sine qua non for eligibility. Under these proposed amendments, more investors could qualify as accredited based on their professional experience or certifications. For example, those holding a Series 7, 65 or 82 license to sell securities are eligible under the proposed changes, as is the case with similar credentials earned from an accredited institution.
Certain LLCs and Rural Business Investment Companies (RBICs) would qualify as accredited investors if they meet a minimum $100 million threshold. A new category is proposed for entities, which would include Indian tribes, with net worth exceeding $5 million in investments to move into the accredited investor category. Again, the entity could not have been formed with the idea of investing in these specific securities in mind.
The proposed rule also changes “spouse” to “spousal equivalent” for the purpose of pooling funds to qualify as accredited investors. That means you need not wed your long-term partner if he or she has the means to qualify you in the net-worth department.
