The Securities and Exchange Commission (SEC) was created 80 years ago to protect investors, while also nurturing the growth of efficient and transparent markets for securities. Over the intervening years, the balance between protection and growth has shifted many times, leading to many sets of requirements with conditions and exemptions to parse in order to determine entrepreneurs’ notice and filing requirements, and the range of investor opportunities and protections.
One special balancing of protection and growth applies to what the Securities Act of 1933 and SEC rules call “accredited investors.” As of this writing, several statutory and regulatory initiatives are changing who qualifies under this term, and the sources of information they may use to make investments to which they have special access.
Who’s Presently an Accredited Investor?
"Accredited investors” are individuals or entities deemed to have sufficient financial and investment sophistication that they can make larger and/or riskier investments, based on information from issuers that might not be enough to protect more mundane investors. SEC’s 1933 Act Rule 215 and Regulation D Rule 501 presently define accredited investors as any of the following:
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A bank, insurance company, registered investment company, business development company, or small business investment company
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An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million
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A charitable organization, corporation, or partnership with assets exceeding $5 million
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A director, executive officer, or general partner of the company selling the securities
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A business in which all the equity owners are accredited investors
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A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person
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A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year
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A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
Qualifying offerings to accredited investors are exempt from securities registration requirements, providing huge sums (mostly to smaller companies). For example, SEC estimates that over $1 trillion was raised using the Regulation D exemptions in 2011 alone, comparable to the capital raised in registered offerings in that year.
What’s Happening to the Definition of Accredited Investor?
On June 26, 2013, U.S. Supreme Court invalidated the federal Defense of Marriage Act (DOMA; the case is United States v. Windsor). DOMA had mandated that “marriage” and “spouse” exclude same-sex partners, so same-sex spouses’ assets and income could not be considered under items (6) and (7). Without this federal prohibition “spouse” reverts to a state-defined term, allowing investors in a growing number of jurisdictions (presently 13 states plus the District of Columbia) to consider their same-sex spouses.
Other changes may be in the offing. Section 413 of the 2010 Dodd-Frank Act directs SEC to review income and net worth thresholds for accredited investor status at least every 4 years, and Section 415 directs the Government Accountability Office (GAO) to study and report within 3 years on appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status. GAO issued its report on July 18, 2013, including the following observations:
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The $1 million net worth threshold has been in place since the 1980s. Adjusting it for inflation would yield approximately $2.3 million, decreasing the number of households qualifying as accredited from approximately 8.5 million to 3.7 million.
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Alternative criteria might be considered, including the level of individual investors’ liquid investments, and whether they use a professional investment adviser.
Since GAO encourages SEC to incorporate these considerations into the Commission’s formal review of accredited investor criteria, stakeholder groups have already begun to register their reactions.
What’s Happening to Information Requirements?
On July 10, 2013, SEC released two revisions to Rule 506 of Regulation D, adjusting eligibility requirements for use of Regulation D offerings (effective September 23, 2013).
The first revision implements the requirement from Section 926 of Dodd-Frank, by adopting subsection 506(d) disqualifying securities offerings involving specified categories of “felons and other bad actors” from reliance on the Rule 506 exemption from registration. This Rule applies to the following:
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The issuer itself
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Directors and certain officers, general partners, and managing members of the issuer
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20 percent beneficial owners
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Promoters
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Investment managers and principals of pooled investment funds
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Persons compensated for soliciting investors (including general partners, directors, officers, and managing members of any compensated solicitor).
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Criminal convictions (within 10 years before the proposed sale, or 5 years for the issuer and its predecessors and affiliates) in connection with the purchase or sale of a security, making of a false filing with SEC or arising out of the conduct of certain types of financial intermediaries
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Court injunctions and restraining orders (within 5 years) in connection with the purchase or sale of a security, false filings with SEC, or the conduct of certain types of financial intermediaries
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Final orders (within 10 years) from the Commodity Futures Trading Commission, federal banking agencies, National Credit Union Administration, or analogous state agency that bar the issuer from associating with a regulated entity, or engaging in these businesses, or based on fraudulent, manipulative, or deceptive conduct
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Certain SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies, and investment advisers and their associated persons
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SEC cease-and-desist orders related to violations of certain anti-fraud provisions and registration requirements of the federal securities laws
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SEC stop orders and orders (within 5 years) suspending a Regulation A exemption.
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Suspension or expulsion from membership in a self-regulatory organization (SRO), or from association with an SRO member
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U.S. Postal Service false representation orders (within 5 years).
The second revision expands implements Section 201(a) of the 2012 Jumpstart Our Business Startups (JOBS) Act, by eliminating existing prohibitions against “general solicitation” and “general advertising” in offerings to accredited investors under Rule 506, if the offeror takes “reasonable steps to verify” that all purchasers actually are accredited investors” (Rule 506(d)) (this release also allows general solicitation and advertising under Rule 144A’s exemption, if the seller “reasonably believes” that actual buyers actually qualify). These changes mean there will be no restriction on who can be solicited, but the seller must take appropriate steps to verify that each purchaser qualifies—replacing a common practice under which purchasers self-certify but sellers do not investigate further.
What’s Next?
A number of these requirements are in flux, and SEC is due to conduct a formal review of accredited investor qualifications within the next year. If your organization is involved with accredited investors, and/or if you are an accredited investor, you should watch these developments closely.
Implementation Checklist
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Does the organization plan to sell securities, claiming exemption from federal registration requirements under Regulation D for sale to “accredited investors?
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If so, does the organization use “general solicitation” and/or “general advertising” to inform and encourage potential purchasers?
- If so, does the organization take steps to verify that all purchasers under that exemption actually qualify?
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Does the organization plan to sell securities, claiming exemption from federal registration requirements under Rule 144A to “qualified institutional buyers?
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If so, does the organization use “general solicitation” and/or “general advertising” to inform and encourage potential purchasers?
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If so, does the organization take steps to verify that all purchasers under that exemption actually qualify?
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Are you an individual who invests in securities sold under Regulation D exemption from registration requirements?
- If so, do you qualify as an “accredited investor”?
Where Can I Go For More Information?
SEC provides a Fact Sheet on Accredited Investors, with links to Regulation D and related topics, on its website
The Supreme Court’s US v. Windsor decision is available here
GAO’s report, Securities and Exchange Commission – Alternative Criteria for Qualifying As an Accredited Investor Should Be Considered (GAO-13-640) (July 2013), is available here
SEC's Release adopting disqualifications for felons and bad actors (Release No. 33-9414) appears on the Federal Register website
SEC's Release adopting a general exemption from (Release No. 33-9415) appears on the Federal Register website
STP publishes the following related guides:
About the Author
Jon Elliott is President of Touchstone Environmental and has been a major contributor to STP’s product range for over 25 years. He was involved in developing 16 existing products, including Environmental Compliance: A Simplified National Guide, Greenhouse Gas Auditing of Supply Chains and The Complete Guide to Environmental Law.
Mr. Elliott has a diverse educational background. In addition to his Juris Doctor (University of California, Boalt Hall School of Law, 1981), he holds a Master of Public Policy (Goldman School of Public Policy [GSPP], UC Berkeley, 1980), and a Bachelor of Science in Mechanical Engineering (Princeton University, 1977).
Mr. Elliott is active in professional and community organizations. In addition, he is a past chairman of the Board of Directors of the GSPP Alumni Association, and past member of the Executive Committee of the State Bar of California's Environmental Law Section (including past chair of its Legislative Committee).
You may contact Mr. Elliott directly at: tei@ix.netcom.com.