Under the Dodd-Frank Act of 2010, the Securities and Exchange Commission (the “SEC”) is required to examine the definition of “accredited investor” every four years to determine if it should be modified. Under the current standard, a natural person qualifies as an “accredited investor” for purposes of participating in a Rule 506 offering if he or she has earned at least $200,000 in annual income in each of the two most recent years ($300,000 for married couples) or has $1 million in net worth, exclusive of one’s primary residence.
While the monetary thresholds for accredited investor status have not been changed since they were drafted in 1982, the SEC effectively increased the net worth requirement in 2010 by excluding the value of an investor’s primary residence. In the four years since that change, the SEC is once again determining whether the definition needs to be modified further. Presently, the SEC is considering adjusting the thresholds for inflation. According to the Government Accountability Office (the “GAO”), such a change would raise the requirements to $500,000 in income for two most recent years ($700,000 for married couples) or $2.5 million in net worth, excluding the primary residence. The GAO’s analysis estimates that moving to this more restrictive standard would eliminate approximately 60% of current accredited investors from investing in private offerings. To managers of nascent hedge funds, such a change would make fundraising even more difficult.
All may not be lost with the proposed amendment, however. In response to a letter from Rep. Scott Garrett, SEC Chairwoman Mary Jo White noted that the accredited investor standard may be expanding and contracting in concert. Specifically, her letter stated that the SEC was examining:
- Whether individuals with certain professional accreditation should be considered accredited investors regardless of whether they satisfy the income and net worth tests, including certified public accountants, chartered financial analysts, experienced financial professionals (generally, anyone with a securities license), and legal counsel;
- Whether individuals with degrees in business, finance, accounting or economics should be considered accredited investors solely based on their education; and
- Whether an investor’s reliance on a qualified broker or registered investment adviser should enable an ordinary investor to be able to participate in Rule 506 private placement offerings.
It is expected that the SEC will issue a final rule on the accredited investor standard by the end of the year, with an effective date likely in the first quarter of 2015. An increased income and net worth standard will certainly make capital formation more difficult going forward, but much of its effect can be blunted if the SEC incorporates additional accreditation metrics that are not income or net worth based.
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