The SEC's New Definition of Accredited Investor

While this year was a lot of things, the Securities and Exchange Commission bestowed upon the investing world a change in the definition of accredited investor. Some commentators indicated that the amendment leaves much to be desired, however, this blog post will briefly detail that expansion. To understand where we are now, we must understand where we came from.

What was the old definition of an accredited investor?

The previous definition left an accredited investor to be an individual who earned more than $200,000 annually for the past two years or more than $300,000 combined with their spouse. It also included people who had an individual or combined net worth of more than $1 million, excluding the value of their home.

The theory behind such a limited definition of an accredited investor is to protect individuals from the risks involved with investing in private companies.The thought was that if someone does not meet that criteria then they are not as savvy as a high net worth individual.

What is the new definition of an accredited investor?

Recently, the SEC expanded the definition of accredited investor to include individuals, businesses, and governmental bodies that satisfy certain requirements other than income or net worth.

Individuals

Professionals can qualify as an accredited investor based on…

“certain professional certifications, designations or credentials issued by an accredited educational institution.”

Additionally, holders in good standing of the Series 7, Series 65, or Series 82 licenses are considered to be qualified. The Series 7 license qualifies a candidate “for the solicitation, purchase, and/or sale of all securities products, including corporate securities, municipal securities, municipal fund securities, options, direct participation programs, investment company products, and variable contracts.” The Series 65 exam is designed to qualify candidates as investment adviser representatives and covers topics necessary for adviser representatives to understand to provide investment advice to retail advisory clients. The Series 82 license qualifies candidates seeking to affect the sales of private securities offerings.A holder must have an active license to be considered an accredited investor.

A potential investor may also invest in a private fund as an accredited investor so long as the potential investor is a “knowledgeable employee” of the fund. A knowledgeable employee is any natural person who is an “Executive Officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity” of a private fund. In short, the amendment allows the general partner, CEO, etc. of the issuer to be an "accredited investor" for the limited purposes of investing in the securities being offered.

The inclusion of knowledgeable employees will permit these employees to invest in the private fund without the fund itself losing accredited investor status when the fund has assets of $5 million or less. Under Rule 501(a)(8), private funds with assets of $5 million or less may qualify as accredited investors if all of the fund’s equity owners are accredited investors.

Additionally, for those potential investors who are married, the spouses can now pool their resources together for the purposes of qualifying as an accredited investor.

Businesses

The expansion of the definition permits family offices with at least $5 million in assets under management and their family clients to fall within the definition of accredited investor. The definition of a family office is a company that has no clients other than family clients that is wholly owned by family clients and is exclusively controlled by family members or family entities and does not hold itself out to the public as an investment adviser.

The amendment opened up accredited investing to a slew of business entities. Limited liability companies with $5 million in assets, SEC and state-registered investment advisers and rural business investment companies may qualify. Qualification varies based on entities and it is recommended that entities seeking qualification consult with a securities attorney.

Currently, the SEC does not believe that sole proprietorships should be distinguished from other registered investment advisers for purposes of determining accredited investor status.

Governmental Bodies

With the amendment expanding who and what can be an accredited investor, the SEC permits government entities to act as accredited investors. What is included in a government body are

Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) of the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.

These rules are set forth in Rule 501(a) (1-12), mostly (1), (3), and (10).