In the financial world, an accredited investor is a person or a business corporation with a special status under the financial regulation laws. These kinds of investors range from high income individuals, financial institutions, banks to large corporations that have access to high-risk investment portfolio like trust funds, angel investments and venture capital.
The U.S SEC press released by chairman, Jay Clayton on August 26 2020, made amendments to define an accredited investor. This was to include individuals who initially, did not meet specific tests on income or net worth and were thus not eligible for the opportunity to invest in the massive and complex private markets, their financial sophistication notwithstanding. The amendments now effectively include these individual investors and institutions who have the necessary professional knowledge and expertise to participate in these private capital markets. The other entities permitted to participate in these markets are tribal markets and other organizations who are qualified to participate in the private offerings.
An accredited investor is legally approved and authorized to purchase securities which are not registered with the regulatory bodies such as the SEC. Some companies may decide to raise capital for expansion through a private placement by selling their stocks, bonds or shares to pre-determined investors instead of an Initial Public Offering (IPO) through the open market. They are exempted from registering the securities with the SEC thus saving them a lot of money, though there is the potential risk that these accredited investors face. Consequently, these investors need to safeguard their financial stability, be knowledgeable and experienced about these ventures. The buyers of these private placements claim more returns than they compared to what they can get on the open markets.
Requirements for Accredited Investors
The Security and Exchange Commission (SEC) instituted accreditation in 1982. Some jurisdictions may vary in their regulations for an accredited investor based on the different dynamics in the local market regulator or the present authority. In the U.S, an accredited investor is defined by the SEC Rule 501 of Regulation D.
Interestedly enough, the benchmarks to be accredited haven’t change since 1982. Never adjusted for inflation or population growth. What has changed however, are the number of accredited investors that qualify today vs 1982. Originally, there were only 500,000 qualified investors. Today there are in excess of 11,000,000.
An individual is qualified to be an accredited investor if they report an annual income of more than $200,000, or $300,000 for joint income, in the last two years. This is with the expectation of earning the equal or a higher income in the current year. For the income test to be satisfied, the individual’s income for one year must not show a joint income with a spouse for the next two years, and vice versa.
A net worth exceeding $1 million for either an individual or a joint account with a spouse also places one to be an accredited investor. An executive officer, a general partner or a director of a company that is issuing the unregistered securities is also considered an accredited investor by the SEC.
For an entity, if it is an organization or a private business development company whose assets exceed $5 million, then it is considered an accredited investor. Also, if it has equity owners who are accredited investor, then the entity itself is an accredited investor. That being said, an organization cannot be formed with the solely for purchasing specific securities.
Purpose for the Accredited Investor Requirements
A regulatory body has the responsibility of safeguarding the investors and promoting their interests. The regulators are also in business and they look into making profits by promoting investments in risky ventures and entrepreneurial undertakings. These might be risky initiatives and the chance for failure might be high because they generally focus on development activities and research based on concept only, without any product that can be marketable. The investors stand to make huge returns if these ventures are successful.
The less knowledgeable individual investors in terms of risks associated with their investments need to be protected by the regulators. This is because they are likely to have less financial protection in the event that high losses occur.
There is no defined process for one to become an accredited investor. However, the responsibility is on the sellers of the securities to take steps in verifying the status of individuals or entities who claim to be accredited investors and wish to be treated as such.
For the individuals or parties who wish to be accredited investors, they send an application to the issuer of the unregistered securities. A questionnaire may be presented to the applicant for the purpose of determining if they qualify to be an accredited investor. Several attachments accompany like account information, balance sheets and financial statements. These attachments might include salary slips, tax returns, W-2 forms, letter from investment brokers, tax attorneys and an evaluation of credit reports for extensive assessment.