By: Neli Traykova
On August 26, 2020, the U.S. Securities and Exchange Commission (“SEC”) adopted amendments to the “accredited investor” definition, which becomes effective 60 days after publication in the Federal Register.[1] Although the “accredited investor” definition is one of the main ways to determine who is eligible to participate in the private capital markets, it has remained unchanged for over 35 years.[2] Based on the old definition, the test to qualify a natural person as an “accredited investor” was based purely on income and net worth, requiring more than $1 million in net worth or earnings over $200,000 per year in the prior two years.[3]
Thus, if individual investors did not meet the net worth or income requirements, they were unable to invest in private markets, despite their financial sophistication, knowledge, or expertise.[4] The SEC found that this approach was largely “unsatisfactory” and began the effort to improve and modernize the framework.[5] The SEC ultimately expanded the definition of “accredited investor” by incorporating an alternative to the net worth and earnings test for individuals who hold professional certifications, designations, or credentials, thereby demonstrating an understanding and sophistication in securities and investing.[6] The new definition also allows “knowledgeable employees” of private funds to qualify as an “accredited investors.”[7] This change allows for less affluent individuals, who are able to make informed investment decisions, to invest in offerings they were previously not able to invest in.
The old definition based on wealth, largely disadvantaged individuals and businesses in lower income areas.[8]Lower income areas translate to less qualified accredited investors thus, businesses in such areas had a harder time finding investments.[9] Minority and women-owned businesses were disproportionately disadvantaged as the founders are more likely to lack a wealthy network.[10] Although there is criticism that the definition change will result in more private offerings, these private offerings will be extremely beneficial to finance small and local businesses by allowing financially sophisticated persons to participate in the private market.[11]
A major concern of the definition change is that by expanding the “accredited investor” pool with more qualified individuals, private financing will increase, therefore resulting in fewer public companies.[12] However, according to SEC Chairman Jay Clayton, that is not the case.[13] Rather than taking investors away from public capital markets, the amended definition will allow sophisticated investors different opportunities to invest and expand their portfolios.[14]Thus, the expanded definition will likely have little effect on the public securities market while potentially lending a much needed helping hand to small businesses by qualifying more investors.
[1] Statement on Modernization of the Accredited Investor Definition, Securities and Exchange Commission (Aug. 26,2020), https://www.sec.gov/news/public-statement/clayton-accredited-investor-2020-08-26 [hereinafter Statement by Chairman Clayton].
[2] Id.
[3] See 17 CFR § 230.501(a)(5) (defining “accredited investor” under Regulation D).
[4] Press Release, Securities and Exchange Commission, SEC Modernizes the Accredited Investor Definition (Aug. 26, 2020) [hereinafter SEC Press Release].
[5] See Statement by Chairman Clayton, supra note 1 (“The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess the bear risk has long been unsatisfactory.”); see also SEC Press Release, supra note 4 (noting that the Commission’s effort began in June 2019, by requesting public comments).
[6] See Amending the “Accredited Investor” Definition, Release No. 33-10824, 1, 12-14 (Aug. 26, 2020) (including a list of “attributes” the Commission may consider when qualifying a person as an “accredited investor”).
[7] See id. at 35 (defining “knowledgeable employees”).
[8] Statement by Chairman Clayton, supra note 1.
[9] See id. (noting that small and early stage businesses were the most disadvantaged).
[10] Id.
[11] See id. (discussing the pros and cons of the expanding private market).
[12] Evie Liu, The SEC Changed Its Rules. Not Only the Rich Can Invest in Private Market., Barron’s (Aug. 26, 2020, 4:39pm), https://www.barrons.com/articles/sec-eases-rules-on-accredited-investors-51598474360.
[13] See Statement by Chairman Clayton, supra note 1 (highlighting the SEC’s dedication to increasing “the attractiveness” of the public markets).
[14] Id.
