Financial Wealth vs. Financial Wisdom: Rethinking the Accredited Investor Definition
Insights From the Publisher: The SEC is once again reviewing the accredited investor definition. Could a new approach unlock private markets for a wider range of Americans?
By Damon Elder, publisher and editor-in-chief, The DI Wire
The accredited investor definition is a cornerstone of U.S. securities regulation, playing a pivotal role in who can participate in certain investment opportunities. The U.S. Securities and Exchange Commission has been tasked with reviewing this definition at least every four years to ensure it aligns with investor protection and the broader economic landscape.
Of course, in a free society, why in the world does the government have the right to determine how we can invest our money? Shouldn’t we all be empowered to make our own decisions in this regard? Shouldn’t the SEC focus on policing, rather than restricting the liberty of free people?
I think the answers to these questions are pretty obvious, but the fact remains that we have, as a society, allowed the government to exercise control over our own free will in terms of our ability to invest where we choose. This is at least until we can establish, by the accumulation of enough wealth, that we are smart enough to invest our own money how we choose by earning the coveted “accredited investor” definition. As such, absent the unfortunately fantastical notion that we as a people would object to the types of bureaucratic control over our financial liberty, we should focus on what can be done to improve the investor definition of an accredited investor so that more Americans can exercise their option to invest in private securities.
Historically, the definition has been based on financial thresholds, including income and net worth requirements, with the idea that individuals meeting these thresholds are financially sophisticated enough to understand and bear the risks associated with unregistered securities offerings. Generally, the guidelines, pursuant to Rule 501 of Regulation D of the Securities Act of 1933, have required an individual to meet at least one of two criteria:
- A net worth exceeding $1 million, excluding the value of their primary residence, either individually or jointly with a spouse; or
- An annual income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000) and a reasonable expectation of maintaining the same income level in the current year.
The SEC has made several amendments to the definition over the years, most recently in August 2020, expanding the categories of who qualifies. These changes included recognizing:
- Individuals who have certain professional certifications and designations;
- Individuals who are “knowledgeable employees” of private funds, but only in regard to that specific fund;
- SEC-registered and state-registered investment advisers;
- Individuals who are “family clients” associated with a “family office,” and who meet specific requirements; and
- Directors, executive officers, and general partners of the issuer or of a general partner of the issuer.
The SEC released a staff report in December 2023, once again reviewing the definition. While the report did not recommend changes, speculation remains that the commission may move toward narrowing the definition, possibly by excluding assets accumulated in defined contribution plans from the net worth calculation and/or adjusting the income and net worth thresholds for inflation. This would mean fewer individuals would qualify as accredited investors, limiting their access to potentially lucrative investment opportunities in the private markets.
This potential move by the SEC to narrow the definition of an accredited investor is concerning and misguided. Restricting investment opportunities based on wealth is a fundamentally flawed approach that perpetuates inequality and limits the ability of many Americans to grow their wealth through diverse investment options.
The very foundation upon which the accredited investor definition is built is offensive. Wealth does not necessarily equate to financial acumen, and the SEC’s arbitrary financial thresholds are an inaccurate measure of an investor’s financial sophistication. Not only do they clumsily group together lottery winners and heirs with those who actively earned their wealth through financial knowledge, but they exclude those individuals who have grown their “financial chops” but have yet to build up substantial savings.
Along these same lines, the exclusion of primary residences from the net worth calculation is illogical. For many Americans, their home is their most significant asset. Excluding it distorts the picture of their true financial standing and unfairly excludes them from investment opportunities.
Additionally, wealth thresholds are insufficient to determine who can “afford” investment losses. Loss tolerance is complex and depends on a number of factors such as age and individual investment goals. Older investors may be more risk-averse than younger ones, and investors may have diverse motivations beyond financial returns, such as supporting local businesses or diversifying their portfolios. The SEC’s definition fails to capture these nuances.
Instead of narrowing the definition, the SEC should focus on expanding access to investment opportunities for all Americans. Some possible methods to accomplish this goal might include the following.
- An accredited investor exam: The SEC could develop a specific, comprehensive financial literacy exam or a series of educational modules that, upon successful completion, would grant individuals accredited investor status. This approach would focus on knowledge and understanding of investment risks rather than solely on wealth.
- Investment track record: The commission could consider an individual’s investment history. An individual with a proven history of successful investing in public markets could be deemed capable of handling the risks of private markets.
- A broader regard for professional experiences: Certain professions, such as lawyers, accountants, or financial analysts require a high level of financial knowledge. The SEC could recognize these professions as qualifying criteria for accredited investor status, as they already do with certain financial certifications.
- Hybrid model: The SEC could adopt a hybrid model that combines financial thresholds with other criteria. For instance, an individual could qualify if they meet a lower net worth or income threshold and also pass a financial literacy exam or have relevant professional experience.
- “Emerging” accredited investor: A new sub-category of “emerging accredited investor” could be created with lower financial thresholds but limited investment options. This would allow individuals with less wealth to participate in certain private offerings deemed less risky.
These potential alternative definitions would allow further access and help to ensure that individuals who are genuinely knowledgeable and capable of understanding the risks involved could participate in private markets, regardless of their net worth.
The accredited investor definition is a critical aspect of securities regulation that must be modernized. As is it stands now, it a tool for exclusion, limiting the ability for middle-income and low-income individuals to amass wealth and diversify their portfolios. This harms both investors and those entrepreneurs who depend on those investments.
Instead, the accredited investor definition can be a gateway to opportunity. By rethinking the criteria and focusing on financial sophistication rather than wealth, the SEC can create a more inclusive and equitable investment landscape for all Americans. Absent a perfect world where we can eliminate such objectionable control over our financial freewill, this may be the best we can hope for.
Damon Elder is the publisher and editor-in-chief of The DI Wire. He has worked in the alternative investments industry for nearly 20 years. He was previously a congressional aide and political consultant before finding honest work in the private sector. Agree or disagree? Share your views with him at damon@thediwire.com. Thoughtful replies may be published in The DI Wire.
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