Recently, the U.S. Securities and Exchange Commission (SEC) held a meeting to discuss recommendations from its Investor Advisory Committee (IAC) regarding broadening the definition of an “accredited investor” for natural persons. Under the Dodd-Frank Act, the SEC must review the accredited investor definition every four years. This is the first review of the definition since Dodd-Frank was enacted in 2010. The committee discussed several potential changes for improving the definition of accredited investor in their recommendations. However, the agency is not obligated to adopt the IAC’s recommendations.
The IAC voted on a reform plan that recommends the SEC rethink the income and net-worth minimums for accredited investors. IAC asked the SEC to consider alternative criteria that serves as a more accurate proxy for the purpose of defining the class of investors that have sufficient financial sophistication. Rather than suggesting an increase for the financial thresholds for accredited investor status, the IAC recommended that the SEC should revise rules for defining a sophisticated investor as someone who can participate in private securities offerings. The committee asserted that relying on income and net worth “over-simplifies the factors that determine whether an individual truly has the wealth and liquidity to shoulder the potential risks of private offerings.”
Under current rules, an investor is accredited if he or she has a net worth of more than $1 million, excluding their primary residence, or an annual income of $200,000 or more ($300,000 for a married couple). About 8.5 million people fit this category, according to various estimates. These thresholds don’t provide adequate protection for investors whose net worth is based on retirement or illiquid holdings, such as farmland, the IAC noted.
The IAC argued that if the financial thresholds were merely increased, several disadvantages would remain. Using income and net worth thresholds will ultimately include investors that lack financial sophistication, ignore investors’ liquidity that will help withstand potential losses, include retirement savings used as regular income. Moreover, investors just under the threshold are totally excluded, while investors that barely satisfy the thresholds have no limitations on investing as much of their income or assets as they want. Increasing the thresholds would merely restrict the pool of capital available to private offerings without addressing these issues.
Moreover, the limited number of non-accredited investors who can participate in private offerings based on a recommendation from a purchaser representative should get stronger protection. The IAC also recommended that the SEC should strengthen protections for non-accredited investors who qualify by relying on advice from a purchaser representative, and take meaningful steps to develop an alternative means of verifying accredited investor status which shifts burden away from issuers. Any such representative should be required to act in the investor’s best interest, the committee said.
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