The SEC presents several rules defining who can and cannot take part in the investment scopes/opportunities not recorded/registered under the Securities Act. To participate in the securities offerings, a capable investor must be eligible or qualify as an accredited investor. Over the years, the definition of accredited investors has been under the scanner. In December 2020, the US SEC (Securities and Exchange Commission amended the definitions of an accredited investor in 501 (a) and Rules 2015 of Regulation D, proclaimed under the 1933 Securities Act. It is a positive transformation that expands investment opportunities to wider sections. Understanding the amendments or changes is critical to seeking the advantage of the up-to-date and modern definition.
What is the Reason behind the Changes or Amendments?
Over several years, the definition has been criticized because of its focus on the income/asset income test. It is biased as the test excludes every wealthy investor from profitable investment scopes or opportunities. In response to the criticisms, the SEC began to consider different methods or ways to expand the definition of an accredited investor. After a long wait, the SEC made changes and adopted the amendments that included more investors participating in the securities offerings. The amendments or changes have included more sophistication in certain portions of the definition and modernized the out-of-date terms/terminologies.
Inclusion of Knowledgeable Employees
Knowledgeable employees are eligible as accredited investors in the present SEC definition. Such employees in the accredited investor definition include the following from a private investment company:
- Director
- Trustee
- Executive officer
- Advisory board members
- Company employees
The new definition broadly includes all the executives of a private investment firm. It only incorporates specific non-executive employees. SEC’s concern is that such a change in the definition might give protection or security to those candidates who lack adequate financial knowledge and expertise.
For knowledgeable employees, it is not a concern because, by the nature of their position, they need to gain adequate experience and knowledge about finance to make informed decisions. Every employee at a private investment firm doesn’t possess the same financial expertise and sophistication. The determining factor of a non-executive employee participating in the security offerings depends on a case-by-case basis.
The presence of knowledgeable employees in the accredited investor definition allows more employees to invest without the private investment organization risking their status as accredited investors. Under 501 (a) (8) rule of Regulation D, proclaimed under the Securities Act, a private investment organization with an asset of $5,000,000 or less is eligible to participate as an accredited investor.
Before adopting the amendments and changes, private investment firms lost their status as accredited investors if they allowed their candidates/employees to invest in the firm’s security offerings. Under the new definition, several private investment firm employees qualify to invest. It creates an additional source of capital for the organization and aligns the interests of the employees with the firms.
Professional Credential or Certifications
Individuals with specific professional credentials, certifications, and designations qualify to become accredited investors. They have a certain level of financial expertise and sophistication and do not need to possess financial assets to become an accredited investor. Before the amendments, only individuals with financial or broker advisor licenses (Series 82, Series 65, and Series 7) could participate in security offerings as accredited investors. After the amendments, the SEC grants eligibility to individuals with professional designations.
Inclusion of Some Entities
Several entities have been included in the new SEC definition of an accredited investor. The inclusion expands the presence of LLCs (Limited Liability Companies), rural business investment companies, and investment advisors. In 1989, when the definition was last made up-to-date, LLCs were rare and didn’t hold importance for inclusion as an entity. Over the years, LLCs have emerged significantly, and the amendments include the entity to modernize the definition.
Conclusion
With the amendments and changes in the definition of an accredited investment, there is a higher level of flexibility and sophistication in the participation. The changes and amendments have expanded the SEC definition and increased the number of potential accredited investors. SEC has adopted the changes to instill financial sophistication and modernize some portions of the existing definition.