On Aug. 26, the SEC amended its definition of an “accredited investor.” An accredited investor is an investor or an entity that's allowed to participate in private capital markets. Previously, the SEC only recognized investors with a specific income level or net worth that invest in private markets, regardless of their financial sophistication.
What was an "accredited investor" previously?
Historically, according to the SEC, accredited investors included:
- Anyone who earned more than $200,000 annually for the past two years or more than $300,000 combined with their spouse.
- Someone with a net worth of over $1 million, either alone or together with a spouse (excluding the value of their primary house).
Why is there a separate set of rules for accredited investors?
The rules regarding accredited investors are designed to protect individual investors. Private markets are usually considered to be riskier and less transparent. Only high net worth investors were allowed to participate. However, the regulations received criticism for excluding investors based on their wealth measures alone and reserving the investment opportunities for already wealthy people.
In the past, Tesla CEO Elon Musk highlighted how all Tesla investors could remain with the company even if it went private. He suggested creating a special purpose fund to allow everyone to stay with Tesla. However, Tesla never went private.
The SEC has expanded the accredited investor definition to include measures based on professional knowledge, experience, or certifications in addition to the existing tests for income or net worth. Individuals will be allowed to participate in private markets based on certain criteria. The list of eligible entities has also been expanded.
SEC's new rules for an accredited investor
According to the new SEC rules, entities and individuals that meet an “investments test” will qualify as accredited investors. SEC chairman Jay Clayton said in a statement, “For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations that may qualify to participate in certain private offerings.”
The amendments to Rule 501 (a) include:
- There's a new category that allows natural persons to qualify as accredited investors.
- With respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund will be included.
- Limited liability companies with $5 million in assets may be accredited investors.
- There's a new category for any entity, including Indian tribes, funds, governmental bodies, and entities organized under the laws of foreign countries.
- The SEC added “family offices” with at least $5 million in assets under management and their “family clients.”
- Spousal equivalents can pool their finances to qualify as an accredited investor.
Examples of accredited investors
Some examples of accredited investors include a company, charitable organization, or partnership with at least $5 million in investments. Any individual with a net worth of more than $1 million and an income of $200,000 for each of the past two years would also be an accredited investor. Therefore, Elon Musk, Jeff Bezos, Mark Zuckerberg, and other high net-worth individuals easily qualify as accredited investors.