What’s in a name? Sometimes plenty, which is one reason why the House of Representatives recently passed H.R. 2187, the Fair Investment Opportunities for Professional Experts Act. The move follows years of discussion regarding whether the existing definition of “accredited investor” should be amended. As passed by the House, the bill retains the name but broadens the existing definition of “accredited investor” to include two additional categories of individuals able to meet the definition notwithstanding their net worth or income level.
Background
Under the Securities Act of 1933, any company offering or selling its securities must either register with the SEC or be exempt from registration. One commonly used exemption is known as a Regulation D offering, which permits a company to sell its securities to “accredited investors” without registering with the SEC. As such, it is critical to understand the requirements of “accredited investor” status.
The purpose for limiting securities offerings to accredited investors is rooted in the SEC’s efforts to protect small-scale investors from engaging in risky investments that could result in losses that they are unable to financially withstand. Since 1982, the definition of accredited investor has required that investors satisfy an income or net worth test, based on dollar amounts that have remain unchanged since that time.
Specifically, an investor satisfies the existing accredited investor test under Reg D, Rule 501(a), if the investor either (1) earned income in excess of $200,000 individually (or $300,000 together with a spouse) in each of the two previous years, and reasonably expects the same earned income in the present year; or (2) has a net worth over $1,000,000, excluding the value of the investor’s primary residence. Notably, prior to Dodd-Frank the net worth test could be satisfied without exclusion of the primary residence. That change, made on the heels of the recession and housing market crisis, was intended to further ensure that individual, small-scale investors had liquid assets sufficient to cushion potential investment losses.
Dodd-Frank also charged the SEC with the task of reviewing the definition of accredited investor for individuals beginning in 2014 and every four years thereafter. As part of its review, the SEC requested public comments and formed advisory committees that have made recommendations on the issue. The comments and recommendations have ranged from leaving the existing financial thresholds in place, to adjusting them for inflation, to adding new categories of investors that could satisfy the accredited investor test independent of the financial thresholds.
Proposed New Definition
In April, 2015, H.R. 2187 was introduced in the House directing the SEC to revise the definition of accredited investors for natural persons. The legislation, which passed the House on February 1, 2016, proposes the following changes to the accredited investor definition:
- Net Worth Inflation Adjustment – Although the $1,000,000 threshold remains the same, the proposal would adjust that amount for inflation every five years, to the nearest $10,000, to reflect the change in the Consumer Price Index.
- Broker/Investment Adviser Category – The proposal expands the accredited investor test to include licensed or registered brokers and investment advisers.
- Education/Job Experience Category – The proposal further expands the accredited investor test to include individuals that the SEC determines, by regulation, to have demonstrable and verified education or job experience to qualify as having professional knowledge of a subject related to a particular investment.
In sum, except for the going-forward inflation adjustment in the net worth test, the existing financial thresholds were left in place. The proposal adds two additional categories of individuals able to satisfy the accredited investor test even if they would fail the income and net worth thresholds. The new categories presumably demonstrate the type of financial sophistication that an investor needs in order to make informed and responsible investment decisions.
The education/job experience category instructs the SEC to determine an investor’s professional knowledge by regulation. Whether this will include a test or other objective measure of investment aptitude remains to be seen. The accredited investor test is primarily intended to protect unsophisticated and undercapitalized investors from the inability to recover from risky investment losses. It will be interesting to see how the education/job experience category will be measured to ensure that every law student, for example, isn’t bestowed accredited investor status along with his JD. Upon law school graduation, I’m not sure many of us would have described ourselves as sophisticated or financially sound prospective investors.
Takeaways
Although legal issues pertaining to Reg D offerings may not be encountered by business or estate planning attorneys with any frequency, the accredited investor test is among the basic securities law concepts important for any attorney to understand. Today, after almost 35 years, it appears that there is real momentum behind changing the definition of accredited investor, opening the door to investment opportunities previously unavailable to many individuals. As a result, attorneys may see an uptick in clients seeking legal advice pertaining to potential investments and should be prepared to discuss with clients the changing requirements for accredited investor status.
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