The Securities and Exchange Commission (SEC)’s Investor Advisory Committee has recommended changes to the definition of accredited investor that consider other ways of measuring financial sophistication.

In a public statement released Wednesday, the SEC indicated that time is ripe for the SEC to review the appropriate conditions for determining whether someone is or isn’t an “accredited investor”.

SEC: Exemption from registration requirements

The current definition of “accredited investor” attempts to identify those individuals who are anticipated to be able to fend for themselves and protect their interests when participating in financial markets. The current definition attempts to do this by focusing on whether an individual has either an annual income of at least $200,000 per year ($300,000 with their spouse) or a net worth of at least $1 million.

SEC Explores Re-visiting “Accredited Investor” Definition

The SEC’s public statement from Commissioner Luis A. Aguilar points out that the definition of “accredited investor” is critical to the SEC’s Regulation D exemption from the registration requirements of the Securities Act of 1933. Moreover, it points out that Regulation D may be the SEC’s most widely used exemption offering. Furthermore, it is regularly used by small businesses to raise funds in the capital markets.

The SEC’s statement also notes generally speaking, securities offerings made to “accredited investors” under Rule 506 of Regulation D are exempted from the registration and disclosure requirements of federal securities laws and the securities purchased cannot be freely resold.

Current definition fails to consider financial sophistication

However, the SEC notes the “accredited investors” are not only individuals like Bill Gates or Warren Buffett, but could include a large swath of Americans such as a senior retiree who has accumulated over $1 million in his or her retirement account and needs that money for his/her retirement years.

The SEC points out that under the current scheme of income and net worth tests, there is nothing in the “accredited investors” definition that helps to ascertain whether these individuals have the financial sophistication and/or investment experience to be able to assess whether any particular investment is appropriate for them.

The SEC statement also notes that the SEC’s IAC has pointed out that the current “accredited investor” definition may be under-inclusive. The SEC points out that potential investors who most people would consider to be financially sophisticated, such as a Chartered Financial Analyst or a graduate professor of corporate finance, may not have the income or the accumulated net worth to be eligible to be “accredited investors,” but are actually better able to protect their own interests.

The SEC’s public statement therefore points out that the IAC has recommended changes to the accredited investor definition by considering other ways of measuring financial sophistication, including assessing an individual’s specialized work experience, investment experience, licensing or other professional credentials.

Interestingly, as detailed by ValueWalk, the Hedge Fund Association expressed concern over the potential changes the SEC is contemplating to the definition of “accredited investor,” saying it would narrow the number of potential investors in hedge funds, private equity, venture capital funds and real estate investments.