Review of the Accredited Investor Definition Under Dodd-Frank
On December 14, 2023, the Securities and Exchange Commission (SEC) released a staff report on the definition of accredited investor, examining the current status of the accredited investor pool and discussing several proposals to modify the definition of accredited investor.
- This is the third such staff report on this topic after the SEC evaluated the definition of accredited investor in 2015 and 2019.
- Commenters are requesting amendments to the definition of accredited investor that would narrow or broaden the number of households that would qualify as accredited investors.
The Bottom Line
Although the staff report does not take a position on the several proposals discussed in the report, the SEC is requesting comments from the public and any interested parties.
On December 14, 2023, the SEC released a staff report on the definition of accredited investor. This staff report is the third staff report on this topic after the SEC evaluated the definition of accredited investor in 2015 and 2019. The SEC has substantively amended the definition of accredited investor four times since adoption of Regulation D under the Securities Exchange Act of 1933, as amended, in 1982 and most recently in 2020. Although the SEC did not take any positions on any proposed changes, the staff report expressed interest in soliciting the views of the public and interested parties.
Under the Dodd-Frank Act, which was enacted in 2010, the SEC is required to evaluate the definition of an accredited investor every four years for the protection of investors, in the public interest, and in light of the economy. When the SEC amended the definition of accredited investor in 2020, it committed to monitor the characteristics of the individual accredited investor pool, especially the income and net worth thresholds. The SEC is particularly focused on the extent to which accredited investors have financial sophistication, ability to sustain the loss of investment and access to information that have traditionally been associated with an ability to fend for themselves, as well as, the impacts to participation in Regulation D offerings. The definition of accredited investor is also applicable to Regulation Crowdfunding, Regulation A Tier 2 offerings, Section 12(g) of the Exchange Act, FINRA Rule 5123 and state securities laws.
Under Rule 501(a), the definition of accredited investor provides that natural persons and entities that come within, or that the issuer reasonably believes come within, any of 13 enumerated categories at the time of the sale of the securities is an accredited investor, which include, among others
- directors, officers, and general partners of the issuer;
- individuals who have a net worth exceeding $1,000,000 (excluding the value of an individual’s primary residence) either alone or with the individual’s spouse, and
- individuals who had income in excess of $200,000 in each of the two most recent years (or joint income with a spouse in excess of $300,000) and have a reasonable expectation of reaching the same income level in the current year.
In 2020, the SEC expanded the definition to include natural persons holding good standing in certain professional certifications or designations.
The definition of accredited investor is central to the scope of Rule 506 offerings. Offerings conducted under Rule 506(b) may have an unlimited number of accredited investors but no more than 35 non-accredited investors, and all investors in a Rule 506(c) offering must be accredited investors. Any change in the definition of an accredited investor would impact the scope of such offerings.
The staff report estimated that, in 1983, the year after Regulation D went into effect, 1,510,000 households (or 1.8% of all U.S. households) qualified as an accredited investor and, in 2022, the number of qualifying households had increased to 24,300,000 (or 18.5% of all U.S. households). The increase is partially explained by the addition of a joint income prong in 1988 and a professional certificate prong in 2020, but the SEC estimates that the steady increase is largely due to the fact that the natural person income and net worth thresholds have not changed to reflect inflation and the expanded role of retirement savings.
The staff report discussed the following proposals to amend the definition of accredited investor but did not take a position on any of the proposals.
Excluding Retirement Assets From the Calculation of Net Worth
Some commenters have called for retirement assets, especially assets held in a defined contribution plan, to be excluded from the calculation of net worth because a retirement account may not be an appropriate proxy for investor sophistication given the increase in U.S. retirement assets, and an individual investing for imminent retirement may not be able to bear potential losses even with substantial assets. The staff report estimates that 12.5% of U.S. households would qualify as an accredited investor under the net worth prong under the current definition, but only 8.8% of U.S. households would qualify as an accredited investor if retirement assets were excluded from the calculation of net worth.
Adjusting Net Worth and Income Thresholds for Inflation, Geography, and Other Disparate Impacts
The SEC has received comments requesting a one-time threshold adjustment and/or index-based approach that adjusts the income and net worth thresholds on a going-forward basis. Other commenters have advocated for lowering the thresholds to allow more households to qualify as accredited investors, especially in certain regions with a lower cost of living, such as rural communities. Income and net worth thresholds provide a proxy for investors who do not need the protections of federal securities laws, but many commenters point out that these thresholds are arbitrary. Some commenters called for replacing the thresholds with non-financial metrics to reduce the diversity, equity, and inclusion barriers for accredited investors.
Adding an Experience Requirement to the Financial Credentials Prong
The SEC has received comments requesting that an individual who seeks to qualify as an accredited investor due to a financial credential also be required to meet certain experience requirements. Commenters raised concerns that there would not necessarily be a correlation between a financial credential and an ability to bear an economic loss.
Adding Additional Measures of Sophistication
The SEC has received comment that additional prongs for investing limits and qualitative measures of sophistication be considered. One proposal asked the SEC to consider a rule that allows any person to qualify as an accredited investor if such person does not invest more than 10% of the greater of his/her annual income or net assets. The commenters suggest that an investing limit prong would allow more households to qualify as an accredited investor while continuing to protect investors. Other commenters suggest that the definition of accredited investor require demonstrable investment experience, which more closely aligns with sophistication.
The SEC has expressed its interest in the public’s views regarding the definition of accredited investor and welcomes all feedback from interested parties. The report did not provide a deadline for such feedback.
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