Statement on Modernization of the Accredited Investor Definition

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SEC | Chairman Jay Clayton | Aug 26, 2020

accredited investor definition - Statement on Modernization of the Accredited Investor DefinitionToday, the Commission adopted final rules to modernize and add much needed flexibility to the definition of “accredited investor” by adding new categories of qualifying individuals and entities that have demonstrated financial sophistication such that they should not be excluded from the very large, multifaceted and important private capital markets.  The private capital markets are important to investors and issuers of various types, as well as our economy more generally.  The accredited investor definition is the principal test for investor participation in significant segments of our private capital markets.  It also plays an important role in other state and federal securities law contexts.

The test for individuals to qualify as accredited investors has largely remained unchanged for over 35 years. This test relies exclusively on a person’s income and net worth.  If you make enough money or have sufficient assets, you are eligible to participate, and if you do not, you generally are not eligible.  The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess and bear risk has long been unsatisfactory.  Individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks of participating in unregistered offerings, are denied the opportunity to invest in our private markets.  For example, using only a binary test for wealth disadvantages otherwise financially sophisticated Americans living in lower income/cost-of-living areas.

See:  SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments

Moreover, businesses – particularly smaller and early stage businesses, those in geographic areas with lower concentrations of accredited investors, or founders without a wealthy friends-and-family network – are unable to seek investments from otherwise financially sophisticated individuals to access much needed seed and growth capital.  When small and medium-sized businesses often, and increasingly, rely on local sources of capital, particularly at the seed and initial growth stages, these restrictions are limiting and almost certainly stifle opportunity. It has been noted that these wealth-based limits on opportunity can have a disproportionate impact on minority- and women-owned businesses and other underrepresented founders.

With respect to the Commission’s updates for institutional investors, we have received broad, almost universal support for our modernization efforts, including our long overdue recognition of tribal governments, governmental bodies, and family wealth management vehicles as sufficiently sophisticated to participate in the private markets.   In light of that support, I will focus the remainder of my comments on the individual investor test and a few issues that have been raised.

We are expanding the definition of accredited investor to include an alternative to the wealth test for natural persons — specifically, persons who hold certain professional certifications and designations and other credentials from accredited educational institutions.  The Commission will be able to designate these by Order based on a number of criteria.  The initial certifications include the Financial Industry Regulatory Authority, Inc. (FINRA) Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82) certifications.  There is no doubt persons who have successfully obtained these certifications – and maintained them in good standing – are sufficiently financially sophisticated to participate in the private markets.

See:  Comment Period Ends on Proposal to Update the US Definition of an Accredited Investor. So Who Said What?

During the notice and comment period, there have been several criticisms of these modest, incremental efforts to modernize our accredited investor rules that I would like to address.  It has been suggested that expanding the accredited investor definition to include these clearly sophisticated persons will result in more private financings.  Some think this is a positive development, some think it is negative.

When you look more closely, and in particular recognize that there are many segments in the private markets and many types of private financing, it is only positive.  Any expansion in private financing due to these amendments, given the limited nature of the expansion of the accredited investor definition, is likely to be most meaningful in the area of small, local business financing.

Adding clearly financially sophisticated persons to the pool of persons eligible to participate in these financings is a laudable and unassailable policy goal.  Of course, many have asked us to go much further in expanding the pool of eligible investors, citing, for example, the wealth gaps faced by underrepresented founders and the importance of improving access to capital for underserved businesses and communities.

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A number of commenters on the Commission’s efforts in the private markets space have noted that women, minority and other underrepresented entrepreneurs, as well as those outside of the coastal urban areas where traditional venture capital investment has been more focused, often do not have an existing network of wealthy friends and family and, as result, struggle to access capital.

Our Small Business Capital Formation Advisory Committee continues to explore how we might better serve these important segments of our markets.  These are important issues to consider, and I hope that our Small Business Capital Formation Advisory Committee and our Investor Advisory Committee will continue to aid the Commission in seeking improvements to the definition and other areas of regulation that will enhance access to capital in these areas.

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