Since the early 1930s, federal government regulators have found it challenging to protect investors in private offerings and securities while simultaneously sustaining the growth of start-ups and other young companies - companies which many believe are responsible for the majority of job growth in the United States. Balancing this task had been forefront in the mind of the Securities and Exchange Commission (“SEC”) for years. Eventually, the SEC coined the term “accredited investor,” thereby shaping the investment landscape ever since. This distinction was implemented by the SEC to protect investors who did not have the sophistication nor the resources to obtain disclosures and to evaluate private securities offerings. By creating this standard, the SEC felt comfortable allowing individuals with the financial means and sophistication to participate in these private securities offerings, without the full protection of federal or state securities laws.
According to Regulation D of the Securities Act of 1933, the term accredited investor refers to any investor who has maintained a certain level of income or net worth and who is able to participate in private placement of securities. It also allows an investor to participate without being counted toward the maximum number of investors that are otherwise permitted in an offering exempted under Regulation D. In July of 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which made an important amendment to the definition, in that the value of a primary residence may no longer be included in an individual's net worth. This amendment came in the wake of the rising – and then falling – of real estate prices across the country. This dramatic bubble led to the concern that the value of a personal residence might be based on overoptimistic perceptions, and that the inclusion of that personal residence in the “net worth” criteria of an individual's wealth might be inappropriate.
While it may be most common to think of accredited investors as individuals, this group also includes banks, insurance companies, employee benefit plans, and trusts. For an individual, though, in order to qualify as an accredited investor, he or she must meet one of the following criteria:
- Earn an annual income exceeding $200,000 or joint income exceeding $300,000 together with a spouse.
- Have a net worth exceeding $1 million - excluding one’s primary residence.
- Be a general partner, executive officer, director or a related combination thereof for the issuer of a security being offered.
The SEC considers these accredited investors to have sufficient amount of wealth, as to not need the protection of federal and state securities laws to the same extent that non-accredited investors do. In other words, they have the ability to fend for themselves.
The question of how the SEC can both protect individual investors while still allowing for growth of startups and other young companies will continue to be a hot topic in the coming years. As the SEC proved when they removed the value of primary residency in the valuation of accredited investors, they are paying close attention. We can expect that the SEC will continue to implement reforms that could limit the number of accredited investors in years to come. Stay tuned.