Proposed Changes to Regulation D


Among the regulations governing hedge funds are the restrictions found in Regulation D of the Securities Act of 1933. Those restrictions allow hedge fund investment only from “accredited investors” who are defined as individuals with a minimum net worth of $1,000,000 or a minimum income of $200,000 in each of the last two years (for a couple, the minimum household income is $300,000 in each of the past two years) and a reasonable expectation of reaching the same level in the current year. In 2010 the Dodd-Frank Wall Street Reform Act (Dodd-Frank) revised the definition by excluding one’s primary residence from the net worth amount; however, aside from that revision, the qualifications have remained unchanged for over 30 years. Recently proposals have been introduced to further amend Regulation D.

Allowing for Inflation

Since the qualifying amounts to be an accredited investor have not changed since the 1980s, inflation has made those amounts less significant in terms of filtering out prospective investors and has in fact opened the doors to millions of such investors who now total 8.5 million. If the current amounts were to be adjusted for inflation—as per current proposals—it is estimated that the number of Americans who can qualify as accredited investors would drop to 3.75 million.

Heightened “Qualified Purchaser” Minimums

Under Dodd-Frank, authority was extended to the Securities and Exchange Commission to adjust the net worth and income standards for individuals. While banks and corporate entities must have a minimum of $5,000,000 in total assets, investors in the larger hedge funds must also meet the definition of a “qualified purchaser” under the Investment Company Act of 1940, which likewise requires individuals to have a minimum of $5,000,000 in investments.

Impact on Startups

The notion of reducing the number of accredited investors comes at a time when American entrepreneurship is just beginning to get a new kick start. Under the JOBS Act, startups are allowed to engage in general solicitation for investors which has resulted in a significant funding boost for hi-tech companies. By changing the definition of an accredited investor, the ranks of eligible investors for these initiatives would be greatly reduced. According to Steven Cinelli, a crowdfunding expert, “The accredited investor definition is an anachronism. Trying to morph an old law into the digital generation is an inherent waste of time, and focus should be spent on improving disclosures.”

Alternative Thresholds

The exclusionary nature of the current income and net worth tests have prompted some pundits to propose alternative standards relating to level of education or prior experience as an investor. Whether such criteria will serve as legitimate benchmarks to protect the unsophisticated investor is a matter still under review.