Accredited Investor Minimums Might Increase Soon—Here’s How That Impacts Investors

A December report issued by staff of the U.S. Securities and Exchange Commission (SEC) discusses several potential modifications to the accredited investor definition, as suggested by sources like the Investor Advisory Committee and the Small Business Capital Formation Advisory Committee. 

The Dodd-Frank Act of 2010 requires the SEC to review the definition every four years in light of changes in the economy. The goal is to maintain sufficient protection for unsophisticated investors while providing for investor participation in exempt offerings that play an important role in innovation and economic growth. 

The report is merely an attempt to evaluate frequently suggested changes and collect public comments on the various options rather than a rule-making document. Several of the proposals involve narrowing the accredited investor definition on account of inflation or other concerns, while others are intended to broaden the definition by introducing new measures of sophistication. It’s important to understand the implications of amending the definition in either direction and submit a comment if you have information to add to the discussion. 

Striking a Balance Between Consumer Protection and Access

Part of the SEC’s mission is to protect investors by ensuring they have access to critical information to help them evaluate potential investment opportunities and by holding companies accountable for fraud and dishonesty. The Securities Act of 1933 aims to accomplish these goals by requiring a rigorous registration process for public offerings, along with certain disclosures, and by establishing civil liabilities for investor losses resulting from misleading or altogether false statements. 

However, the SEC recognizes the requirements of the Securities Act are cumbersome to businesses and may actually impede another important aspect of the independent government agency’s mission, which is to promote access to capital, allowing businesses to innovate in ways that benefit society and build wealth for investors. Small businesses, which create the majority of new jobs and are vital to the health of the U.S. economy, are particularly reliant on access to capital. That’s why the Securities Act exempts certain offerings from the full registration and disclosure requirements, including private offerings made to a limited number of investors and small public offerings. 

But to ensure that the more loosely regulated offerings don’t harm investors who lack the expertise or financial solvency to take on the risk required, some securities, such as Regulation D offerings, must be exclusively offered to accredited investors or only offered to a limited number of non-accredited investors under the Securities Act. Changing the accredited investor definition impacts the pool of investors who can legally participate, which in turn affects the scope of Regulation D offerings. 

When Regulation D first went into effect, a relatively small share of the population qualified as accredited investors. But the SEC has amended the definition multiple times since then. Most recently, the SEC adopted changes in 2020 that allowed more people and entities to qualify under professional criteria without needing to be shareholders or satisfy financial eligibility requirements. 

For example, select licensed investment professionals can now qualify, as can some family offices and family clients. That change expanded the pool of accredited investors. Other changes, such as the 2011 decision to exclude investors’ primary residences from their net worth calculations, may have diminished the pool. 

But over time, the various changes to the definition, along with inflation and other factors, have significantly increased the share of the population eligible to be accredited. The SEC report estimates that only 1.8% of U.S. households qualified for accredited investor status in 1983. By 2022, the share increased to 18.5%. 

To qualify as an individual accredited investor in 2024, you generally need to meet one of the following criteria: 

• Have a net worth greater than $1 million, individually or with your spouse, excluding the value of your primary residence.
• Have income exceeding $200,000 individually or $300,000 with your spouse over the past two years, with a reasonable expectation that income will continue in the current year.
• Hold one of three investment professional licenses in good standing.
• Be a director, executive officer, or general partner of the issuing company.
• Be a “family client” of an eligible “family office.”
• Be a “knowledgeable employee” of the private fund issuing the security.

Entities must qualify under one of several separate categories.  

Proposed Amendments to the Accredited Investor Definition

The restrictiveness of the accredited investor definition has long been debated. In 2021, U.S. Congressman Mike Flood (R-Nebraska) and Congressman Wiley Nickel (D-North Carolina) introduced the Equal Opportunity for All Investors Act, which passed with bipartisan support in the House. If enacted, the legislation would allow investors to qualify by passing a Financial Industry Regulatory Authority (FINRA)-administered exam that would be available to the public free of charge. 

Some argue that the SEC shouldn’t have a role in protecting consumers from their financial choices, while others contend the SEC needs to look beyond wealth when determining eligibility. Lawmakers debated the extent to which the SEC should restrict investors from participating and the methods the agency should use to qualify investors in a House hearing last February. 

The SEC staff report includes both suggestions that would tighten eligibility requirements and those that would expand access to more investors, but the SEC could take action in both directions simultaneously. For example, the agency may make it easier for certain investors to qualify by introducing new measures of investor knowledge and experience while also making it harder for investors to qualify based on net worth and income alone. 

The intent of all this is to allow the right pool of investors to participate—those who understand the risks and can sustain the losses—rather than simply increasing or decreasing the share of investors who are eligible to participate. 

These are some of the proposals the SEC is evaluating. 

Rethinking retirement savings

Employees are playing a greater role in funding their retirement accounts now than when Regulation D went into effect in 1982. While defined benefit plans were once more common, the number of participants in defined contribution plans grew from 23.4 million in 1982 to 85.3 million in 2020. Some commenters say a well-stocked retirement account isn’t an appropriate indication of sophistication. 

The report also notes that while retired or near-retired adults may have high account balances that allow them to qualify as accredited investors, they may have difficulty recovering from financial losses due to having few earning years left. If the SEC were to exclude retirement savings when calculating an investor’s net worth, that would shrink the pool of accredited investors who qualify based on net worth from 12.5% of households to 8.8% of households. 

Concerns about the new professional credentials qualification

Some commenters expressed concern over whether the three investment professional licenses that have allowed individuals to qualify since 2020 are sufficient measures of an investor’s capability to bear losses, with some recommending the addition of an experience requirement. Commenters also cautioned the SEC not to consider additional professional credentials because broad criteria may lead to weaker investor protections. 

Changing the thresholds for net worth and income

Some commenters have suggested changing the net worth or income thresholds required to become an accredited investor, either with a one-time adjustment or on an ongoing basis, to account for inflation. The report notes that if the established income and net worth thresholds were adjusted for inflation, that would reduce the share of households that qualify to between 5.7% to 6.51%, depending on the inflation adjustment method applied. 

The Small Business Advisory Committee suggested lowering the thresholds in certain areas of the country where a lower cost of living would allow individuals of a lower net worth to weather financial losses while periodically increasing all thresholds on an indexed basis. Other commenters suggested abandoning the financial thresholds altogether in favor of other metrics that would provide more equitable access to Regulation D offerings. 

Measuring sophistication in new ways

The SEC’s Small Business Forum brought recommendations that the agency consider other ways of demonstrating sophistication. Similarly, an annual report from the SEC’s Office of the Advocate for Small Business Capital Formation suggested adding other qualifying professional licenses and other ways of evaluating investment savvy in lieu of net worth or income requirements. 

An alternative to a fixed threshold

The Investor Advisory Committee suggested looking at alternative approaches to protecting investors from unbearable risks. 

For example, the SEC could cap investments in private companies at a share of the investor’s income or assets. The SEC could pair that approach with a financial sophistication requirement that might include new ways of demonstrating a sophisticated level of knowledge. Another idea from the Small Business Forum was for the SEC to allow anyone to be an accredited investor as long as their investments don’t exceed 10% of their income or assets, whichever is greater. 

Why the Definition Matters

The SEC has historically maintained that the definition of an accredited investor 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.” In interpreting that definition, the SEC has come up with several ways to establish eligibility, which have evolved over the years but are grounded in the principle that an accredited investor should “have access to the kind of information which registration would disclose,” according to the staff report. 

While some people argue that the government should not be responsible for protecting consumers from making poor choices, Americans on both sides of the political spectrum overwhelmingly support consumer protection initiatives. Restricting unregistered offerings to accredited investors is a critical consumer protection measure because many Americans lack the financial education to comprehend private investments, which have a relatively high risk profile. 

For example, just 57% of Americans are considered financially literate, meaning they can accurately answer three out of four questions regarding risk diversification, inflation, interest, and compound interest, according to a survey by S&P Global. A greater share of people in higher-income groups are financially literate. To make an informed investment decision, a person would need to understand all four of these concepts and more. Furthermore, more than half of Americans have less than three months of expenses saved, according to a report from Bankrate. 

It follows that only a small share of the population should be eligible to be accredited. But how small is too small? There are a couple of issues with any measure that reduces the number of potential investors:

1. Fewer accredited investors would have a disparate impact on startups, particularly businesses owned by women or people of color and founders located in middle America, which tend to rely more on funding from angel investors. That would, in turn, suppress job creation. 
2. Private investments can be an excellent avenue to building wealth, and the incidence of fraud is minimal. Tighter requirements for accredited investors could mean that many Americans get left behind. 

Notably, only a small fraction of the people who are eligible actually invest in private offerings. The gap could be explained by a general lack of education about the available opportunities or that most Americans prefer a risk-averse investment strategy. 

The Bottom Line

Still, the SEC should strive to avoid actions that may suppress business growth unless they are necessary to protect consumers from unwittingly sustaining an unrecoverable financial loss. The revision of the accredited investor definition is, therefore, a critical decision for the SEC, and as an investor, your opinion matters, no matter if the changes would affect your eligibility. 

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.