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The US accredited investor regime at-a-glance

Chris Hamblin, Editor, London, 7 September 2016

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Although US regulators and market participants are paying more and more attention to sophisticated (i.e. 'accredited') investors, the federal authorities have not re-examined their definition of the term comprehensively since its adoption in 1982.

Since that time, general inflation has widened the pool of people who qualify as accredited investors. The Securities and Exchange Commission recently mused in a report that the financial criteria set in 1982 may no longer serve as the most effective proxies for determining when investors do not require the protection that comes from registration under the Securities Act 1933.

The 'accredited investor' definition is a central component of Regulation D. It is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.” It therefore allows such HNW people to participate in investment opportunities that are generally not available to others, such as investments in private companies and offerings by hedge funds, private equity funds and venture capital funds.

Issuers of unregistered structured finance products and debt securities also may rely on Regulation D. Investors in unregistered offerings can be subject to investment risks not associated with registered offerings because some securities law liability provisions do not apply to private offerings, issuers of unregistered securities generally are not required to provide information comparable to that included in a registration statement and the SEC does not review any information that may be provided to investors in these offerings.

Natural persons are accredited investors if their income exceeds $200,000 in each of the two most recent years (or $300,000 in joint income with a person’s spouse) and they reasonably expect to reach the same income level in the current year. Natural persons are also accredited investors if their net worth exceeds $1 million (individually or jointly with a spouse), excluding the value of their primary residence. (Certain enumerated entities with more than $5 million in assets qualify as accredited investors too.)

In addition to being a historical cornerstone of Regulation D, the accredited investor definition plays an important role in other federal and state securities laws contexts and has taken on increased significance as a result of the Jumpstart Our Business Startups Act (the JOBS Act), which required the SEC to revise its rule 50615 to permit general solicitation and general advertising in offerings where all purchasers are accredited.

The rules defining accredited investors changed slightly with the passage of the Dodd-Frank Act, excluding an individual's primary residence from the 'net worth' test. Accordingly, some investors who were accredited before 20th July 2010 are no longer, but any purchase rights (such as preemptive rights or rights of first offer) related to securities in which they invested before that date have been "grandfathered in," as long as certain conditions are met. About the same time as Dodd Frank, the SEC excluded any positive equity that HNW individuals have in their primary residences from the test.

SEC Rule 501(a)(5)160 (17 CFR 230.501(a)(5)) does not define the term 'net worth' but the regulator indicated in 2009 in interpretation 255.14 that it is simply the excess of assets over liabilities and in interpretation 255.49 (3rd July 2014) that assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the net worth test, but only to the extent of his or her percentage ownership of the account or property.

The SEC has been mulling over reforms to the system of late and faces a dilemma. If it makes the pool of accredited investors too small, it might restrict businesses’ access to a crucial source of capital and jeopardise the SEC’s "capital formation mandate." If it makes it too wide, however, it might contravene its "investor protection mandate." It is, after all, one of the basic tenets of the Securities Act that investors in need of protection should receive adequate disclosures before they decide on this-or-that investment.

US accredited investors tend to be older, more highly educated and self-employed in greater proportions than the rest of the general public. In 2013, 9% of the American AI pool was older than 75; 22% was between 65 and 74; 28% was between 55 and 64; 21% was between 45 and 54; 18% was between 35 and 44; and 3% was under 35.

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