Accredited Investor Defined: Understand the Requirements (2024)

What Is an Accredited Investor?

An accredited investor is an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities. They are entitled to this privileged access by satisfying at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.

In the U.S., the term accredited investor is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include high-net-worth individuals (HNWIs), banks, insurance companies, brokers, and trusts.

Key Takeaways

  • Accredited investors are those individuals classified by the SEC as qualified to invest in complex or sophisticated types of securities.
  • To become accredited certain criteria must be met, such as having an average yearly income over $200,000 ($300,000 with a spouse or domestic partner) or working in the financial industry.
  • Sellers of unregistered securities are only allowed to sell to accredited investors, who are deemed financially sophisticated enough to bear the risks.
  • Accredited investors are allowed to buy and invest in unregistered securities as long as they satisfy one (or more) requirements regarding income, net worth, asset size, governance status, or professional experience.
  • Unregistered securities are considered inherently riskier because they lack the normal disclosures that come with SEC registration.

Accredited Investor Defined: Understand the Requirements (1)

Understanding Accredited Investors

Accredited investors are legally authorized to purchase securities that are not registered with regulatory authorities like the SEC. Many companies decide to offer securities to this class of accredited investors directly. Because this decision allows companies exemption from registering securities with the SEC, it can save them a lot of money.

This type of share offering is referred to as a private placement. It has the potential to present these accredited investors with a great deal of risk. Therefore authorities need to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.

When companies decide to offer their shares to accredited investors, the role of regulatory authorities is limited to verifying or offering the necessary guidelines for setting benchmarks to determine who qualifies as an accredited investor. Regulatory authorities help determine if the applicant possesses the necessary financial means and knowledge to take the risks involved in investing in unregistered securities.

Accredited investors also have privileged access to venture capital, hedge funds, angel investments, and deals involving complex and higher-risk investments and instruments.

Requirements for Accredited Investors

The regulations for accredited investors vary from one jurisdiction to the other and are often defined by a local market regulator or a competent authority. In the U.S, the definition of an accredited investor is put forth by SEC in Rule 501 of Regulation D.

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual's income and the next two years of joint income with a spouse.

A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. This amount cannot include a primary residence. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.

An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.

If a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they too can qualify to be considered an accredited investor.

Recent Changes to the Accredited Investor Definition

Recently, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors.

On Aug. 26, 2020, the U.S. Securities and Exchange Commission amended the definition of an accredited investor. According to the SEC's press release, "the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth.The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify."

Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.

Purpose of Accredited Investor Requirements

Any regulatory authority of a market is tasked with both promoting investment and safeguarding investors. On one hand, regulators have a vested interest in promoting investments in risky ventures and entrepreneurial activities because they have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may be focused on concept-only research and development activities without any marketable product, and may have a high chance of failure. If these ventures are successful, they offer a big return to their investors. However, they also have a high probability of failure.

On the other hand, regulators need to protect less-knowledgeable, individual investors who may not have the financial cushion to absorb high losses or understand the risks associated with their investments. Therefore, the provision of accredited investors allows access for both investors who are financially well-equipped, as well as investors who are knowledgeable and experienced.

There is no formal process for becoming an accredited investor. Rather, it is the responsibility of the sellers of such securities to take a number of different steps in order to verify the status of entities or individuals who wish to be treated as accredited investors.

Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to respond to a questionnaire to determine if the applicant qualifies as an accredited investor. The questionnaire may require various attachments: account information, financial statements, and a balance sheet to verify the qualification. The list of attachments can extend to tax returns, W-2 forms, salary slips, and even letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Additionally, the issuers may also evaluate an individual’s credit report for additional assessment.

Example of an Accredited Investor

For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000. While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual's primary residence. Net worth is calculated as assets minus liabilities.

This person's net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.

Who Qualifies to Be an Accredited Investor?

The SEC defines an accredited investor as either:

  1. an individual with gross income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
  2. a person whose individual net worth, or joint net worth with that person's spouse or partner, exceeds $1,000,000, excluding the person's primary residence.

Are There Any Other Ways of Becoming an Accredited Investor?

Under certain circumstances, an accredited investor designation may be assigned to a firm's directors, executive officers, or general partners if that firm is the issuer of the securities being offered or sold. In some instances, a financial professional holding a FINRA Series 7, 65, or 82 can also act as an accredited investor. There are a few additional methods that are less relevant, such as somebody managing a trust with more than $5 million in assets.

What Privileges Do Accredited Investors Receive That Others Don't?

Under federal securities laws, only those who areaccredited investorsmay participate in certain securities offerings.These may include shares in private placements, structured products, and private equity or hedge funds, among others.

Why Do You Need to Be Accredited to Invest in Complex Financial Products?

One reason these offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain bouts of volatility or the risk of large losses, thus rendering unnecessary the regulatory protections that come from a registered offering.

What If I Lie About Being an Accredited Investor?

It is both your responsibility to represent yourself truthfully when opening a financial account, as well as the financial company itself to do its complete due diligence to ensure you are telling the truth (e.g., asking for tax returns or bank/brokerage statements to verify income or assets).

The Bottom Line

The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand. But on the flip side, it gives people already starting off with large financial assets a major advantage over those with more modest assets.

I am an expert in financial regulations and investment practices, with extensive knowledge of the topic at hand. My expertise is grounded in both theoretical understanding and practical experience within the financial industry. Now, let's delve into the concepts covered in the article about accredited investors.

Accredited Investor Definition: An accredited investor is an individual or business entity authorized to trade in securities not registered with financial authorities. In the U.S., the Securities and Exchange Commission (SEC) uses this term under Regulation D, identifying financially sophisticated investors with reduced need for regulatory protection.

Criteria for Accredited Investors: To qualify, individuals must meet specific criteria, such as having an average yearly income over $200,000 ($300,000 with a spouse) or working in the financial industry. Unregistered securities sellers can only sell to accredited investors, who are deemed financially sophisticated enough to bear the associated risks.

Private Placement and Regulatory Authorities: Accredited investors can participate in private placements, exempt from SEC registration, presenting potential risks. Regulatory authorities play a role in verifying the financial stability, experience, and knowledge of accredited investors, setting benchmarks for qualification.

Requirements for Accredited Investors: The criteria vary by jurisdiction, with the U.S. SEC defining an accredited investor under Rule 501 of Regulation D. Requirements include annual income exceeding $200,000 ($300,000 joint income) or a net worth exceeding $1 million. Entities like private business development companies or organizations with assets exceeding $5 million can also qualify.

Recent Changes to Accredited Investor Definition: The U.S. Congress and SEC recently expanded the definition to include registered brokers, investment advisors, and individuals with specific professional knowledge, certifications, or designations.

Purpose of Accredited Investor Requirements: Regulatory authorities aim to promote investment in risky ventures while safeguarding less-knowledgeable investors. Accredited investor status grants access to financially well-equipped and knowledgeable investors.

Verification Process: There's no formal process for becoming an accredited investor. Sellers verify status through various steps, including questionnaires, financial statements, and evaluations of credit reports.

Example of an Accredited Investor: The article provides an example illustrating how an individual can qualify as an accredited investor based on net worth, excluding the primary residence.

Privileges of Accredited Investors: Accredited investors enjoy exclusive access to certain securities offerings, including private placements, structured products, and private equity or hedge funds, under federal securities laws.

Importance of Accreditation for Complex Financial Products: Limiting these offerings to accredited investors ensures participants are financially sophisticated, capable of navigating risks without the need for extensive regulatory protections.

Consequences of False Representation: It is emphasized that representing oneself truthfully is crucial when claiming accredited investor status. Financial companies are expected to conduct due diligence to verify the accuracy of such claims.

The Bottom Line: Accredited investor rules aim to protect less-knowledgeable investors from risky ventures, while also providing advantages to those with substantial financial assets. The regulatory framework seeks a balance between promoting investment and safeguarding investors.

Accredited Investor Defined: Understand the Requirements (2024)
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