The Securities and Exchange Commission (SEC) created the notion of “accredited investors” to ease the tension between their double duty to protect individual investors in private securities offerings and to facilitate capital formation and investment. An” accredited investor” is an individual or an entity that is presumed to not require the protection of federal or state securities laws due to their income or net worth. Currently, an accredited investor is defined by the SEC as any natural person who has over $200,000 in annual income in each of the two most recent years or over $1,000,000 in net worth, excluding their primary residence. Accredited investors also include large institutional investors such as banks, insurance companies, business development companies, and other corporations and companies with total assets in excess of $5,000,000.
Qualifying as an accredited investor is significant because accredited investors may, under SEC rules, participate in investment opportunities that are generally not available to non-accredited investors or “ordinary investors.” 1These opportunities include investments in private companies and offerings by hedge funds, private equity funds, and venture capital funds. Limiting Regulation D offerings to accredited investors is intended to restrict the purchase of complex securities to investors who are wealthy enough to “fend for themselves” and who can withstand significant losses. The SEC maintains that these rules protect investors.
Arguably, the accredited investor rules are in place to prevent non-wealthy people from making risky investments that they cannot afford. As of 2010, only 7.4 percent of U.S. households were accredited based on net worth. This means that only a very small percentage of the U.S. population can actually participate in private offerings, which require accredited investor status.
In 2012, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law, which revised the accredited investor standard.1 he Dodd-Frank Act directs the SEC to review the accredited investor definition as it relates to natural persons every four years to determine whether the definition should be modified or adjusted for the protection of investors, “in the public interest and in light of the economy.” This same year, President Obama also passed the Jumpstart Our Business Startups Act (the “JOBS Act”) which decreased the significance of the accredited investor definition in small business investing.1 This is because with the passage of this Act, accredited investors were no longer the only investors eligible for certain private investment opportunities. Now, non-accredited investors may participate.
In 2020, the SEC adopted changes to the definition of the “accredited investor,” which added new categories of natural persons and entities. These include natural persons who hold, in good standing, certain professional certifications and designations and other credentials designated by the Commission as qualifying for accredited investor status, such as individuals holding Series 7, Series 65, and Series 82 financial licenses. Also, knowledgeable employees of certain private funds may now be defined as “accredited investors” so long as their investments are limited to the employer private fund and other private funds managed by the employer.
These recent changes to the “accredited investor” definition indicate that the SEC may be willing to expand and modernize the accredited investor qualification to include more persons. However, some will argue that the accredited investor rule still needs additional changes if it wants to overcome its role in perpetuating the racial wealth gap and income inequality. The SEC rules as they stand are one more vestige of systemic racism that needs to be eradicated.
According to Mariah Litchenstern of Diverse City Ventures, the SEC should amend the accredited investor definition to allow investors to self-certify as accredited. Under this argument, investors may accomplish self-certification by demonstrating that they have sufficient knowledge and experience in financial and business matters in order to effectively evaluate the merits and risks of the prospective investment. These investors may demonstrate sufficient knowledge through access to legal counsel. Under this approach, many more non-accredited investors, including venture capitalists of color, would be able to invest in other underrepresented entrepreneurs. In the end, this change could help eliminate barriers to wealth building and business growth for underrepresented investors and entrepreneurs nationwide.
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*with edits by Elizabeth L. Carter, Esq., Managing Attorney