Accredited Investor: Your Chance to Comment

The SEC staff has issued its first report on the definition of the term “accredited investor.”

Dodd-Frank requires the SEC to review and report on the definition of “accredited investor” every four years:

to determine whether the definition should be modified or adjusted for the protection of investors, in the public interest, and in light of the economy.

(Dodd-Frank was also the law that disallowed counting an investor’s equity in their primary residence toward the $1M net worth standard.)

The term “accredited investor” is probably the most important defined term in the law of startups. If the SEC was to radically increase the financial thresholds to be an accredited investor, the supply of capital to startups would be cut off.

Thus, it is in the startup community’s best interest to stay actively involved in the dialogue surrounding how this term’s definition will evolve over the coming years. This is not going to be a one time discussion. Dodd-Frank requires this review every four years. So, every four years we have something great to look forward to–a discussion about a very important aspect of the law.

In this, the first report, the SEC staff recommended that the Commission consider any one or more of the following methods of revising the definition:

  • “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.”

You might be curious by what the SEC staff means by “investment limitations.” Here the idea is that no angel investor would be able to invest more than 10% of their income or net worth in any one company.

There are a lot of good ideas in the report:

(1) same sex couples should not be disadvantaged by the way the rules work (it is wrong if the law would do it any other way);

(2) Indian tribes and other entities that currently don’t fall within the list of entities that can qualify as accredited investors should qualify as “accredited investors” if they have at least $5M in investment assets (I agree);

(3) allow persons to take a test to qualify as an accredited investor (I especially like this idea).

But I don’t like the idea of indexing the financial thresholds to inflation. What this will essentially put in motion is a continual cutting off of the pool of accredited investors. Slowly over time, inflation becomes a very powerful force. I did not see any analysis in the SEC’s report about how inflation will slowly reduce the number of accredited investors in places where angels are arguably needed most–like the interior of America.

If you want to comment on the SEC’s work, you can do so at this link.

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