In my previous musings about private placement fundraising and promoting your private capital offering to a broader audience, we explained the requirement of accepting only accredited investors if you choose the Rule 506(c) option for your fundraising. One reason 506 (c) offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated, able to protect themselves and are able to bear the risk of potential loss of their investment.
As a FINRA-licensed broker-dealer, TOBIN typically only sells private placements to accredited investors. In each securities sales process, we must verify that each investor in the private offering, whether retail or institutional, is accredited. Accreditation may be achieved through self-attestation in 506(b) offerings or through third-party verification of eligible investors in 506(c) general solicitation offerings.
So, what is an accredited investor?
The term “Accredited Investor” is defined in SEC Rule 501 of Regulation D of the Securities Act of 1933. The SEC’s current Accredited Investor definition is quite specific and detailed about who qualifies. This definition helps companies raising capital in the private markets to identify the potential investors they may target. This explicit definition also helps prospective subscribers know whether or not they are qualified to invest.1
To simplify this definition for our clients and their investors, an accredited investor who is an individual includes anyone who:
- earned a minimum $200,000 income (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or
- has a minimum $1,000,000 net worth, either alone or together with a spouse, excluding the value of the investor’s primary residence.
An accredited investor which is an entity can qualify in numerous ways, but generally follows along these two paths:
- Any company, entity or trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, or
- Any entity in which all of the equity owners are accredited investors.
Recent expansion of the accredited investor definition
The monetary SEC definition of an accredited investor has not changed with respect to the financial criteria (income and net worth) since 1982.2 While the SEC was required to update its accredited investor rule in 2010 to comply with the Dodd-Frank Act3 to exclude the value of a retail investor’s primary residence from net worth calculations, the financial figures cited above have remained the same.
Despite this pull-back in the breadth of the definition in 2010, in August 2020 the SEC expanded the accredited investor definition to include certain designated professionals, “knowledgeable employees” and others. The SEC also adopted a Rule 506(c) verification accommodation permitting issuers, for up to five years, to rely on a prior verification of an investor’s accredited status if the investor provides a written representation that they continue to qualify and the issuer is not aware of information to the contrary.4
This past June, the U.S. House of Representatives passed legislation to update the definition of Accredited Investor.5 Rep. French Hill (R-Ark.), the chairman of the House Financial Services Committee, sponsored the bill and is the leading advocate on this issue in Congress. I agree with him when he says, “…the current Accredited Investor definition impaired talented, knowledgeable innovators from fully participating in their business formation dream.”
Then, last Thursday, December 11, the House passed H.R. 3383, the Incentivizing New Ventures and Economic Strength Through Capital Formation Act, commonly known as the INVEST Act, with a solid bipartisan vote of 302-123. This bill is a package of roughly 20+ capital-formation and securities-law bills assembled into one legislative package, and which carries forward Mr. Hill’s substantive reforms in a vastly broader bill. This new bill moves forward key objectives – both to broaden investor access and to modernize the definition of “Accredited Investor.” The bill would allow more individuals to qualify as accredited investors based on demonstrable financial sophistication, such as relevant education, job experience or credentials. The bill also creates a pathway to qualification via an exam likely created by FINRA or the SEC.
TOBIN Take: Need for an updated accredited investor definition
I am very passionate about updating the accredited investor rules to allow additional sophisticated investors to access alternative investments. The current definition of Accredited Investor is outdated, inflexible, and not very useful. As you can see, there are numerous discussions going on about how to improve it. That encourages me.
I believe that as momentum builds in the industry to improve access to alternative investments for all investors, efforts to update the Accredited Investor definition will gain traction, and the necessary changes will follow.
So, how do you accredit an investor?
To ensure all investors in your private placement are accredited, you can refer to the SEC guidance or contact Jon Tobin, Judi House or me for assistance. Tobin & Company has a standard form you can use to establish investor accreditation. We are happy to share it with you, as a service to our industry and to private capital sponsors and Reg D issuers. We are even happy to share it with our fellow registered representatives. Just give us a call or drop us an email message.
1 https://www.sec.gov/resources-small-businesses/capital-raising-building-blocks/accredited-investors
2 https://www.heyfuturenexus.com/a-short-history-of-accredited-investors-and-what-comes-next/
Justine Tobin
Founder and CEO
(704) 334-2772
This newsletter is not intended to provide legal or investment advice and no legal or business decision should be based on its content. FYI.