SEC Accredited Investor Report Emphasizes Lack of Sophistication, Retirement Assets
The Securities and Exchange Commission on Friday released a report on its accredited investor definition, noting concerns that expertise was not being emphasized enough in the definition and that retirement assets should be excluded from the wealth threshold.
An accredited investor is someone eligible to invest in private offerings on their own behalf. There are multiple ways to qualify: having a net worth of at least $1 million; having an income of at least $200,000 in consecutive years; being a partner of the entity making the private offering; or holding certain certificates as a financial professional, such as a FINRA registration as a broker/dealer.
The SEC is required to publish a report to Congress every four years evaluating these criteria. In its evaluation, the SEC is charged with considering the sophistication and ability to endure financial losses of those who qualify as accredited investors.
In this year’s report, the SEC noted that the number of accredited investors in both absolute and relative terms has increased significantly since 1982, when this exemption for public registration was created under Regulation D. This is in part due to the fact that the wealth and income caps were never tied to inflation. The SEC report estimated that 3% of households qualified under the wealth and income thresholds in 1989, but in 2022, 18.5% qualified.
Additionally, the report explained that many who qualify do so only due to their holdings in a defined contribution plan. According to the report, 16.44 million households qualify on the basis of their income or wealth, but that number drops to 11.6 million when DC plan assets are discounted.
This has raised concerns that many accredited investors do not have the sophistication to invest in private offerings, since their wealth comes in large part from retirement assets and because they cannot easily endure losses in private markets, since their retirement assets, likely in an individual retirement account, are at stake.
The report explained: “The increase in the size of the accredited investor pool over time as a result of inflation and the expanded role of retirement savings in qualifying as an accredited investor, have led some to question the continuing utility of the financial thresholds as a measure of accredited investors’ ability to sustain the risk of loss of investment with respect to accredited investors who are investing for imminent retirement or to provide income in retirement.”
The report noted that the North American Securities Administrators Association has recommended discounting retirement assets for the purposes of accreditation.
Jay Gould, a special counsel with law firm Baker Botts LLP, says accreditation is not tied to sophistication and he is pleased the report identifies this as an issue. He explains that many accredited investors “are not financially sophisticated at all; they need help.”
He adds that the wealth and income thresholds are not set by statute, and the SEC is actually free to fix the issues identified in the report, though any attempted rulemaking would likely be met with furious industry opposition.
The risk of savers with large IRA accounts losing their retirement savings while investing in private offerings is a “fair concern for the regulators to point out and watch,” Gould says. “If you allow people to blow all their 401(k) money [after rolling it over] on shady private placements, that can be problematic.”
Gould says there are some potential regulatory fixes. The SEC could rule that advisers are in breach of their fiduciary duty if an adviser recommends a client invest more than a certain percentage (say 10%) of their retirement assets in private assets, for example. Similarly, the Department of Labor or IRS could rule that retirement accounts that hold more than 10% in private offerings are no longer tax-exempt. Gould emphasizes that both solutions might shore up retirement security but would not address the issue of sophistication and would be met with intense industry backlash.
Congress is currently considering multiple bills to expand the definition of accredited investor in ways that emphasize expertise. One such bill, the Fair Investment Opportunities for Professional Experts Act, which passed the House of Representatives in June, would permit any adviser or broker registered with the SEC, FINRA or state securities authority to become accredited. It would also permit the SEC to accredit those with expertise in a specific field to invest in private offerings in that field, such as a doctor investing in a medical company.
Similarly, the U.S. House Committee on Financial Services passed the Expanding Access to Capital Act in April, which would allow anyone to become accredited, provided they work with a registered adviser and do not invest more than 10% of their wealth in private holdings. The full House has not yet considered the bill.