SEC Staff Recommends Updates to Accredited Investor Definition

By: Marianne Hudson, ACA Executive Director

December 18 was a very big day for angel investors.  Not only did the SEC put out a staff report that recommends tweaks to the accredited investor definition, but Congress passed a big tax act that makes permanent the 100% exemption of capital gains.  Here’s what you need to know in connected blog posts:

Accredited Investor Definition – A mix of gifts and lumps of coal in our stockings

Not far from the US Capitol Building, the SEC quietly released a report from its staff on the Accredited Investor definition on the same day.  As many angels will remember, the SEC is required to study the definition by Congress in the Dodd-Frank Act.  Time will tell if this staff report fully addresses the requirement or if it informs future rulemaking by SEC Commissioners.

To ACA’s delight, some of the recommendations in the report actually match what our leadership has suggested in multiple meetings and letters, such as allowing people who are sophisticated but don’t meet financial thresholds to be accredited.  As in many things, however, there are also some recommendations in the report that are different than most angels would like.  All in all, the SEC staff’s report could have been much worse – for instance it does not include increasing financial thresholds for income to $450,000 and wealth to $2.5 million as some organizations advocated.

Here are the main summary points, taken directly from the report:

The Commission should revise the financial thresholds requirements for natural persons to qualify as accredited investors and the list-based approach for entities to qualify as accredited investors. The Commission could consider the following approaches to address concerns with how the current definition identifies accredited investor natural persons and entities: 

  • Leave the current income and net worth thresholds in place, subject to investment limitations.
  • Create new, additional inflation-adjusted income and net worth thresholds that are not subject to investment limitations.
  • Index all financial thresholds for inflation on a going-forward basis.
  • Permit spousal equivalents to pool their finances for purposes of qualifying as accredited investors.
  • Revise the definition as it applies to entities by replacing the $5 million assets test with a $5 million investments test and including all entities rather than specifically enumerated types of entities.
  • Grandfather issuers’ existing investors that are accredited investors under the current definition with respect to future offerings of their securities.

The Commission should revise the accredited investor definition to allow individuals to qualify as accredited investors based on other measures of sophistication. The Commission could consider the following approaches to identify individuals who could qualify as accredited investors based on criteria other than income and net worth:

  • Permit individuals with a minimum amount of investments to qualify as accredited investors.
  • Permit individuals with certain professional credentials to qualify as accredited investors.
  • Permit individuals with experience investing in exempt offerings to qualify as accredited investors. 
  • Permit knowledgeable employees of private funds to qualify as accredited investors for investments in their employer’s funds.
  • Permit individuals who pass an accredited investor examination to qualify as accredited investors.

The issue ACA will work on learning more about is the “subject to Investment limitations” in the first bullet in the summary report.  ACA Board member Kevin Laws summarizes everything this way:  “They are recommending capping the total investment of the current definition of accredited investor and creating a new tier above that is uncapped, indexing all limits to inflation but going from this point forward (not going backward), and adding a sophistication test.”

“If this report were adopted,” he notes, “the new accredited investor definition would be as follows:

  1. Over $200K income/$1M net worth excluding primary residence (or $300K/$1M joint with spouse): You can invest into each offering up to 10% of whatever you used to qualify (10% of last year’s income if you qualify on income, or 10% of net worth if you qualify on net worth). 

  1. Above $500K income / $2.5M net worth ($750K / $2.5M joint with spouse): No limits (same as today).

  1. Those numbers would be indexed annually to inflation so they would rise each year. Anybody who already qualifies in the year they invested would qualify automatically for all future investments they are part of.

  1. Sophisticated investors would also count as accredited, regardless of income/net worth. Sophistication is defined as:

  • Anybody who has passed the Series 7, 65 or 82 exams
  • Anybody who has made over 10 private investments (in any capacity, not necessarily your own money). This is key for the angel groups since people could participate in the group (but not invest their own money) and after 10 investments have passed that they’ve performed roles like diligence, term review, etc., then be considered as accredited for future investments.
  • Separate ‘Accredited Investor Exam’ (taking into account pieces of Series 7 and 82 covering private investment knowledge)
  • They also suggest that having a "minimum number of investments" would count (presumably public, too) but they do not make any suggestions as to what that minimum should be.”

ACA and the angel community will have the opportunity to comment on these recommendations, and we’ll do so as we study it in more detail.  Stay tuned.

Tax Benefits - The holiday party starts early with a gift from Congress

(click here for this post)