A Short History of Accredited Investors and What Comes Next

Things tend to move slowly in Washington. It was back in 1982 when the rules for accredited investors were first established as part of Regulation D. It set forth requirements for individuals who invest in securities not registered with the SEC.

To be an accredited investor you had to have annual income of $200,000 annually (or $300,000 for joint income) for the previous two years or have a net worth in excess of $1 million (excluding the primary residence). Now, keep in mind these levels were set in 1982, so if they had kept up with inflation the numbers would be $530,000 annually for the income requirement and $2.65 million for the net worth requirement. But the original numbers have remained constant since 1982 leading to more than 12 million accredited investor households as of 2016.

Now, I have a real problem with the entire concept of accredited investors. There are many people I know who do not qualify as an accredited investor but who would know more about investment products than most billionaires. And conversely, there are many wealthy people who are completely clueless about investing.

The SEC has recognized this problem. Back in 2014 the Investor Advisory Committee of the SEC met to discuss, among other things, updating the definition of an accredited investor. In late 2015 the SEC released this 118-page report reviewing the definition of accredited investors. But still nothing much changed.

In June of last year, the SEC sought public comment on ways to expand investment opportunities for individuals while maintaining investor protections. Then on December 18 they announced a proposal that would update the definition of accredited investors to increase access to a wide range of investments.

Here is a statement from SEC Chairman Jay Clayton on this updated definition:

The current test for individual accredited investor status takes a binary approach to who does and does not qualify based only a person’s income or net worth. Modernization of this approach is long overdue. The proposal would add additional means for individuals to qualify to participate in our private capital markets based on established, clear measures of financial sophistication.

You can read the full 153-page report here but here are the main highlights of what this new definition would entail:

  • Create new categories for people with professional certifications that demonstrate their understanding of investing.
  • A new category for “knowledgeable employees” of private funds.
  • The ability to pool assets with “spousal equivalents” for the purpose of qualifying as accredited investor.
  • A variety of different entities such as family offices, LLCs with more than $5 million in assets, those owning investments over $5 million, unless the entity was formed for the specific purpose of investing in the securities being offered.

While this is an improvement it still misses out on a huge group of people. Those with an active interest and knowledge of investing but who have no formal involvement in the field. I would be in favor of some kind of appropriateness test where investors can prove they are knowledgeable, and they understand the risks of the investment. While this would be challenging to administer, it is certainly possible, and something the UK and other countries do already.

The Deadline For Comments is March 15, 2020

The SEC opened a 60-day comment period on January 15 when they published the proposed rule in the Federal Register. Anyone is free to comment and I will be making my voice heard in this process. I encourage you to do the same.

It has always made no sense to me that anyone could put their entire net worth into a penny stock, or a roulette wheel and regulators did not have a problem with that. But legitimate unregistered investments were off the table. When the SEC finally adopts these new rules hopefully the pool of potential investors for unregistered investment products will expand significantly.