News today from the Securities and Exchange Commission (SEC) that they have updated the definition of “accredited investor.” See their release here. So what does that mean, and why should startups care?
What are we talking about here? The government started actively regulating the investment space just after the Great Depression. Since then, the SEC has focused on protecting investors, and their default approach is to require lots of regulations and disclosures. By the time a company is publicly traded on the New York Stock Exchange or NASDAQ, they have jumped through many hoops. But most companies can’t afford to deal with that level of regulation.
So how does the “accredited investor” definition help? The SEC is less worried about protecting investors who have the financial sophistication to understand an investment opportunity and the financial resources to withstand losses. If a company seeking funds agrees to focus on persuading accredited investors, then the SEC will loosen its rules and simplify the process. Unfortunately, it’s still a thicket of confusing rules to qualify for an exemption, but it’s easier than going public.
What is the accredited investor definition? That’s the news from today. The SEC has issued its final rule that will take effect in 60 days, updating the definition of an accredited investor. The fundamental rule hasn’t changed, namely that both individuals and entities can qualify, and the focus remains on creating bright lines for qualification. For individuals, you can become accredited by:
Wealth. A net worth of at least one million dollars, excluding the value of your primary home.
Income. Earning at least two hundred thousand dollars in each of the last two years (three hundred thousand dollars with a spouse) and the expectation that you’ll earn as much this year.
Role. Serving as a director, executive officer, or general partner of the company that’s selling securities.
Credential. This one is NEW. By earning and maintaining in good standing a professional certification or designation such as the Series 7, Series 65 or Series 82 offered by the Financial Industry Regulatory Authority (FINRA). The SEC estimates that around seven hundred thousand people meet this new standard, and the SEC plans to consider adding more qualifications to this list “after first gaining experience with the revised rules.”
Knowledge. Another NEW factor. By serving for at least a year participating in the investment activities of a private fund, an individual would qualify as a “knowledgeable employee” (including trustees and advisory board members). In this case, private fund basically means a hedge fund, venture capital fund, or private equity fund.
What else is new?
The SEC has expanded the definition of spouse to include “spousal equivalent,” essentially anyone who lives with the individual and has a relationship “generally equivalent to that of a spouse.”
The definition of “accredited investor” is also changing for entities, but that’s beyond the scope of this post. Similarly, the definition of “qualified institutional buyer” is being updated.
What do you think of the changes? At a high level, it’s clear that the SEC made progress on its stated goal “to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.” That said, they could have been more bold in adding recognized qualifications beyond the initial list of FINRA qualifications. Comments acknowledged by the SEC listed several qualifications that would have been sensible. I’m biased, but the Chartered Financial Analyst® (CFA®) designation, the Chartered Alternative Investment Analyst (CAIA)® charter, and the Certified Financial Planner® (CFP®) certification all seem like no-brainers and a missed opportunity. Here’s hoping that they move swiftly to expand the list.
Disclosure: Rahul Keshap serves as a FINRA arbitrator and worked for fifteen years at CFA Institute. Shuru Law represents the CAIA Association on various matters from time to time.