Will Changing the Definition of an Accredited Investor Shrink Access to Capital?
By Kim Lamplough, Partner, Assurance Services
Included in the many requirements of the Dodd-Frank Act is an yet incomplete requirement for the U.S. Securities and Exchange Commission ("SEC") to review the accredited investor definition in its entirety as it relates to natural persons. During much of 2014 and continuing in 2015, the Commission staff, including staff from the Division of Corporation Finance and the Division of Economic and Risk Analysis, has been conducting this review. A critical part of the staff’s review is soliciting and evaluating input from the public and other interested parties, including the SEC Advisory Committee on Small and Emerging Companies.
The goal of the review is to assess whether the definition properly identifies the population of investors who should be able to purchase securities in offerings, without the protections afforded by the registration requirements of the Securities Act.
The possible changes being discussed involve adjusting the economic criteria described below and/or adding alternative criteria for including “sophisticated investors” based on education or certifications.
The standards for qualifying as an accredited investor have remained relatively unchanged since the 1980s. Under the current test, an individual will qualify as an “accredited investor” if he/she earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and reasonably expects the same for the current year OR has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
Based on analysis presented at the Commission’s Forum on Small Business Capital Formation held November 20, 2014, when this definition was first established in 1982, 1.8% of the American households qualified as “accredited investors”. That number has climbed to 9.9% in 2013. If the standards were simply adjusted for inflation, the accredited investor number would be reduced to 3.5% of American households.Some have interpreted this to mean that approximately 60% of private capital will no longer be available for unregistered offerings.Others believe that the decrease in available capital is not proportionate, and that the remaining accredited investors would represent far more than 40% of the currently available capital.
The other possible change being discussed relates to allowing some population to be considered “accredited investors” based on education, certification or experience.This could allow people to qualify as accredited investors based on their financial sophistication. Supporters maintain that income or net worth does not determine a person’s ability to evaluate the risks and potential rewards of an unregistered investment. Opponents believe that an accredited investor should have some minimum ability to withstand the loss of any investment they might make.
There has been quite a lot of discussion about the possible changes to the accredited investor definition and the potential impact on the US capital markets. There is a general belief that tightening the definition impairs capital formation and expanding the definition enhances capital formation. Despite the differences of opinion, everyone appears to agree that it is desirable to balance investor protection with facilitation of capital formation.
Michael Feinstein, Partner, Assurance Services contributed to this article.