September 15, 2020
Accredited Investors: The SEC's Updated Definition & What You Need to Know
On August 26, 2020, the Securities and Exchange Commission (SEC) adopted amendments to modernize and expand the definition of “accredited investor” after several months of deliberation. This is the first significant change that has been made since the early ‘80s.
The important question is, were you impacted? If you were an accredited investor before, the good news is that you still qualify. The even better news is that the SEC’s amendments have made it possible for even more individuals and firms to meet the accredited investor threshold. This means that more people will be able to access lower-volatility, higher-return alternative investments.
Who was previously an accredited investor?
An accredited investor is an individual or company that is able to purchase and trade securities which are not regulated by the SEC. Under the old definition, an individual needed to pass either an income test or a wealth test in order to qualify as an accredited investor. This test requires individuals to earn at least $200,000 per year for the past two years ($300,000 with a spouse) or have at least $1,000,000 in net worth, excluding the value of their primary residence.
Why do these tests exist? One mission of the SEC is to protect investors. Certain private investments, such as private equity, hedge funds or farmland, are not regulated by the Securities Act of 1933. This means they are not subject to the same disclosure requirements as publicly registered offerings like stocks or bonds. For this reason, the SEC views these private investments as “riskier” and requires that investors who access these offerings (accredited investors) be more knowledgeable than the general population. The income and wealth tests were set in 1982 as a proxy for which investors were savvy enough to understand private offerings and financially stable enough to withstand a loss.
Fortunately for individuals who qualify as accredited investors under the existing definition, the SEC has not revised the income or wealth tests. This means that anyone who previously qualified under the tests is still an accredited investor. This is good news. As the Brookings Institute pointed out, if the thresholds were adjusted by CPI, it would more than double both the income and the net worth required to meet the threshold. This would reduce the number of households that are accredited investors from nearly 14% of Americans to less than 5%.
Who qualifies as an accredited investor now?
The SEC’s goal is to make it easier for firms to raise capital, not more difficult. For this reason, the new definition includes an alternative to the income and wealth tests: a knowledge test. Individuals who hold a current Series 7, Series 65 or Series 82 license are now also considered accredited investors. The SEC reasoned that passing these series exams requires knowledge of a broad range of financial concepts and a strong understanding of how capital markets work, making them a good test for financial sophistication.
While this change likely impacts the largest number of people, the recent amendment also makes some other meaningful changes. The SEC has added several new categories of organizations that now qualify as accredited investors, including tribal governments, rural business investment companies, and family offices with more than $5 million in assets. The term “spouse” has also been replaced with “spousal equivalent,” making the wealth test more inclusive and reflective of modern family situations.
As SEC Chairman Jay Clayton put it, these changes add:
“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.”
What is the significance of these changes?
These changes are significant.
First, this change is a win for American businesses. The SEC recognizes that private markets are important, especially for small businesses. More accredited investors will make it easier for these businesses to access capital. Limiting the number of accredited investors to those who could only pass the income or the wealth test had several negative consequences. Differences in cost of living in the U.S. have led to big geographical differences in the distribution of accredited investors. This made it hard for businesses outside of wealthy coastal cities, like farms, to raise money. The narrow definition of accredited investors also made capital formation difficult for women- and minority-owned businesses, which may have had fewer personal relationships with wealthy accredited investors.
For investors, these changes mean that more individuals and firms now have access to alternative investments. Alternative investments, or alternatives, are a broad category of investments including private equity, hedge funds, gold, real estate and farmland. Although the 2012 Jumpstart Our Business Startups Act (JOBS Act) made it easier for non-accredited investors to invest in certain alternatives through crowdfunding platforms, access to many alternative investments remains restricted to accredited investors.
Alternative investments offer investors several benefits relative to publicly traded securities. Their performance is uncorrelated with the performance of public markets, their price is less volatile, and many offer higher returns than stocks or bonds. For these reasons, alternative investments are attractive for portfolio diversification and building long-term wealth.
Next steps for accredited investors
The recent SEC amendments are positive for investors. Thanks to the expanded definition of “accredited investor,” more individuals and entities will be able to diversify and build wealth through the private market and more businesses will have access to capital.
If you are now an accredited investor and are not sure unsure what to do next, consider adding alternatives to your portfolio.
FarmTogether is an innovative, technology-enabled investment platform that provides accredited investors with opportunities to invest directly in institutional-grade US farmland. Farmland is a low-volatility, inflation-resistant asset class, which makes it a good choice for investors who are newer to alternative investments and may have a lower risk tolerance.
FarmTogether’s veteran investment team have more than 70 years of combined experience across farmland, agriculture and real estate. This enables the team to source a curated list of top-quality farmland investments. Investors can get started with a minimum investment of as low as $10,000, which makes it much more accessible than other alternative investments like private equity or hedge funds.
Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.
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