Will you still be an “accredited investor”?

The Securities and Exchange Commission (SEC) is considering changing the accreditation standards used to determine eligibility of investors to participate in private offerings. The current definition of accredited investor was created in 1982 and states that an individual must meet one of the three following criteria:

1. Have had an individual annual income of $200,000 for the past two years with an expectation that it will continue;

2. Have had a household annual income of $300,000 for the past two years with an expectation that it will continue; or

3. Have a net worth of at least $1 million, excluding a primary residence.

Since 1982, the SEC has made two changes to the requirements listed above. In 1988, the SEC added the $300,000 household annual income qualification, and in 2011, the SEC added the exclusion of one’s primary residence to the $1 million net worth threshold. If the current levels of income are adjusted for inflation, then an accredited investor would need (i) an annual income of approximately $500,000, (ii) a household with an annual income of approximately $700,000, or (iii) a net worth of approximately $2.5 to $3 million in assets.

Under the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC must review the definition of “accredited investor” every four years.  The SEC uses the income and net worth thresholds as a measurement for whether an individual has the ability to understand the inherent risks of investing in a private company. There seems to be an ongoing debate on the SEC’s role in regulating who can and cannot invest in private offerings. Should the SEC’s role not go beyond fraud? Is the SEC going too far and actually trying to protect investors from themselves?

Many in the capital raising community are against any changes to the current accreditation standards, and even some argue that there should be an additional qualification solely based upon one’s education or work experience. There are others who argue that there shouldn’t be any qualifications based upon income and net worth; rather we should allow individuals to make their own financial decisions regardless of whether they currently meet the standards or not. Their argument is based on the premise that one’s net worth isn’t directly connected to one’s financial sophistication. 

A change in the qualifications of an accredited investor could significantly decrease the number of eligible investors, and thus render capital raising for businesses much more onerous. According to the CEO of Mission Markets, Ken Marienau, approximately 7% of the United States population currently qualifies as an accredited investor. The General Accounting Office and the SEC estimate that an inflation-based adjustment to net worth would eliminate approximately 60% of the current accredited investors. Consequently, only approximately 3% (a 57% reduction) of the US population would qualify under the new accreditation standards. Increasing the income and net worth qualifications of an accredited investor could have a detrimental impact on startups, jobs, and the economy.

If you are interested in commenting on how or whether the SEC should revise the definition of “accredited investor”, click here.