Not long ago, the ability to invest in private offerings in the U.S. was limited to those whose annualized income and net worth afforded a country-club lifestyle. The requirements were an average income of $200,000 for the last two years ($300,000 for joint income) and/or a net worth of $1 million, excluding the value of one’s primary residence.
The Securities and Exchange Commission ("SEC") also considered someone an “accredited investor” if they were a general partner, executive officer, or director of the company that issued the securities in question.
Only 2 percent of U.S. investors qualified as “accredited” under the SEC’s 1982 standard. At the time, it was a short list intended to limit the potential financial loss only to those with a large enough bankroll to cushion the blow more than a privilege based on investment knowledge.
Added Checkpoints for Compliance
On August 26, 2020, the SEC adopted modernized amendments that allow investors to qualify as accredited investors based on measures other than the existing tests for income or net worth. For the first time, the SEC has expanded its definition to include those who have professional knowledge, experience or specific Financial Industry Regulatory Authority ("FINRA") licenses. Investors with active Series 7, Series 65, or Series 82 FINRA licenses, SEC-registered advisers, exempt reporting advisers, and rural investment companies are now considered to be accredited.
Read the SEC press release here.
Read the final SEC accredited investor rule here.
It took the SEC years of careful consideration and thoughtful analysis to strike a careful balance between expanding opportunities for a larger number of investors and maintaining appropriate investor protections while promoting capital formation. The proposal was adopted by a 3-2 vote, with the dissenting commissioners voicing concern over the decision not to include an adjustor in the definitions of wealth thresholds to address the effects of future inflation.
California’s Newly Minted Accredited Investors
A May 2020 study by Kiplinger Personal Finance found California to have the most millionaires - more than 1.1 million residents - than any state in the country. The Los Angeles-Long Beach-Anaheim metro area alone has more than 360,000 households that have at least $1 million in investable assets.
California also has more than 10 percent of the country’s 160,000 branches of broker-dealer firms, giving it a robust number of FINRA license holders who will qualify as accredited investors when the SEC’s new definition takes effect in October.
Approximately 13 percent of U.S. investors have a net worth of at least $1 million, a six-fold increase since the SEC established its current wealth definitions in 1982. A $1 million net worth then is equivalent to a $2.6 million net worth today. A $200,000 annual income then would equate to a $537,000 income in 2020. Conversely, a $200,000 annual income today would be the same as a $75,000 income in 1982.
Potential Conflicts of Interest
Now that Series 7, Series 65, and Series 82 license holders can qualify as accredited investors, compliance departments will most likely have a larger number of its firm’s employees seeking written approval to invest in private limited offering investments. Chief Compliance Officers should ensure there have adequate procedures in place to confirm that investment opportunities for clients are not being circumvented.
Prepare for October Now
Now’s the time for your firm to update applicable policies and procedures and your Code of Ethics to address the SEC’s expanded accredited investor standard. Core Compliance consultants have expertise in this area and can assist with drafting updates and implementing appropriate internal controls. Contact us at email@example.com or 619-278-0020 to schedule a consultation.