“Accredited Investor” Test Under Review

Screen-Shot-2014-10-26-at-20.05.36 "Accredited Investor" Test Under Review

In 2012, the U.S. Congress passed the Jumpstart Our Business Startups Act (JOBS Act) that enhanced the ability of startup entrepreneurs and those growing their existing businesses to attract investment capital from a wider pool of investors in the general public. In particular, the act allows for equity crowdfunding, thus lowering the participation threshold for certain investments. However, in the interests of protecting the unsophisticated investor, the SEC is weighing changes to the “accredited investor” definition, which could impact the ability of businesses to raise capital. A leading hedge fund trade group has shared its SEC comments submission with the public.

9 Million Currently Qualify

Under the current standards, an accredited investor is one whose net worth exceeds $1 million — excluding a primary residence — or one having annual income of $200,000 or more. More than 9 million Americans are estimated to qualify as accredited investors under this test, which was based on the idea that a high-net-worth or high-income individual can better afford to take the higher risks inherent in hedge fund and startup investments than the middle income wage earner or person of more modest assets.

What the SEC Is Weighing

The SEC is considering changes to the definition of who qualifies as an accredited investor, proposals which would make qualifying as an accredited investor more difficult. Among possible scenarios for qualification revision are the following:

  • (a) Increasing Monetary Thresholds: Under the theory that the 30-year-old guidelines for salary and net worth are too low, the SEC could raise the bar to take into account inflation. This would exclude about 60 percent of those who currently qualify as accredited investors;
  • (b) Non-Financial Proof of Sophistication: In lieu of relying upon raw financial statistics, individuals with certain professional licenses could automatically be considered accredited investors;
  • (c) Keep the Pool Intact but Limit the Investments: The SEC could maintain the size of the accredited investor pool but restrict the size of the investment, for example, to a percentage of the person’s income. Critics of this scenario note that no one stands guard over the middle income — or even impoverished — lottery player or slot machine feeder to restrict that person’s “investing.”

Current Tests Outdated

The Hedge Fund Association (HFA), a nonprofit professional trade group representing hedge funds, hedge fund investors and broker dealers has submitted a comments letter to the SEC in response to the proposed changes: “While the HFA fully appreciates and shares the SEC’s goal of protecting investors from making investments which are beyond their financial sophistication, the HFA believes using net worth or income as a litmus test for investor sophistication is outdated.”