The Securities and Exchange Commission (SEC) has announced a change to the definition of an accredited investor, expanding it to include more individuals who can participate.
“The current test for individual accredited investor status takes a binary approach to who does and does not qualify based only on a person’s income or net worth,” said SEC Chairman Jay Clayton about the initial proposal. “Modernization of this approach is long overdue.”
Accredited investors and qualified institutional buyers can participate in certain investment opportunities that are not available to the general public. Ostensibly, these riskier investments in private companies and certain hedge funds, private equity funds, and venture capital funds are limited to shield less “sophisticated” investors.
The final rule adds new categories of persons and entities that can be accredited investors and qualified institutional buyers.
Qualifications for accredited investors will be expanded to include those who pass one of three FINRA administered exams: the Series 7, Series 65, or Series 82. These can be revised, or more can be added at the commission’s discretion. It can also be attained by being a “knowledgeable employee” of a private fund or through credentials from SEC approved educational institutions.
Limited liability companies (LLCs), rural business investment companies (RBICs), Indian tribes, government bodies, funds, and foreign entities may also qualify, as long as they have assets exceeding $5 million. “Spousal equivalents” may also pool their finances to reach the qualification through the net worth route.
LLCs, RBICs, and any other institutional investors included in the accredited investor definition may now be qualified institutional buyers if they satisfy the $100 million threshold.
The changes have been in the works for a little over a year. The SEC requested public comment on a Concept Release regarding the possibility of changing the accredited investor definition last June. In Dec. of 2019, the amendments were formally proposed and were open to public comment for 60 days. The SEC is “adopting the amendment substantially as proposed.”
According to the Investment Adviser Association, around 82 percent of registered adviser clients were not eligible to be accredited investors based on the high net worth requirement in 2019. Consequently, they predict portfolio offerings will be much higher for those non-high net worth clients once the new rule takes effect (60 days after publication in the Federal Register).
The new changes do come with a bit of controversy.
Some commenters who opposed the original proposal were concerned that the newly qualified individuals would not “be able to bear the financial risk of private investments.” One commenter argued against the accredited investor category’s existence and claimed the new FINRA test requirements were inherently discriminatory.
Jordan Carlisle, the VP of economic development and entrepreneurism at the Greater Bentonville Area Chamber of Commerce said on Twitter that the existing rules are meant “to protect lower-income people from getting burned by con-artists,” and “loosening the laws will certainly burn some low net-worth people in the short-run.”
However, he also said, “In the long-run, more people will be able to invest in small private businesses, some startups and some mom and pops. This will be great for communities outside of Silicon Valley and New York.”