Does the Definition of "Accredited Investor" Need to Change?

In the United States, whether or not someone is an accredited investor determines what asset classes one has access to. Historically, non accredited investors have been limited to assets like bonds, mutual funds, 401ks, and stocks. However, those that have met accreditation requirements have had much broader opportunities, which has partially accounted for the growing wealth gap. While amendments to investment regulations such as Reg A, C, and D have taken steps to level the playing field, the definition may soon change even more.

What is an Accredited Investor?

When the current accreditation standards were drafted almost 40 years ago, there was no internet, and information was not as easily accessible as it is today. Therefore, accreditation requirements were created to protect everyday people that may be unfamiliar with investing and its risks from potentially losing all of their money. Yet today, we have vast amounts of information at our fingertips, and a few Google searches may yield days or weeks of research done back in the day. Still, the definition has largely remained unchanged. For an individual to qualify to be “accredited,” he/she must have any one of the following:

  • Have a total household net worth over $1 million
  • Makes over $200 thousand per year or if, both, they and their spouse make over $300 thousand per year in each of the prior two years, and reasonably expects the same for the current year
  • Has a current security license
  • Allows the SEC to determine their accreditation through education or experience through FINRA verification.

Currently, federal law allows funds to be raised privately only from accredited investors. Furthermore, those raising funds cannot merely ask investors if they are accredited. Instead, companies must go through the due diligence to verify accreditation. Failure to do so may result in severe consequences. Companies typically do this through third parties.

Criticisms of Current Accreditation Standards

One of the main issues with accreditation today is that although one may have a particular net worth, they may lack the expertise to make educated financial decisions. Although much wealthier, a professional athlete may have much less investment knowledge than a finance graduate with a far smaller net worth.

Does it make sense to allow the athlete unlimited while denying the student any?

The rules we know today are also ignorant of geographic income differences across the country. For example, $100,000 in a city like New York goes much less than in a place like North Carolina. Thus, those in areas with lower costs of living have been typically excluded by this rule.

What Does the Future Hold?

Recently, new bills have been brought to broaden this definition by adding various categories of investor accreditation and sophistication. It is likely that a lot more will be said on this in 2020. This has been primarily driven by the startup market, which has been stifled by these rules. As this market expands and crowdfunding and equity financing platforms expand, this will be a growing issue.

One option for consideration is implementing standardized tests depending on the asset class one wishes to invest in. Additionally, those with advanced degrees or with special professional designations and licenses may also be exempt. Supplementing the current financial threshold with an additional test of sophistication or factoring a person’s experience, knowledge, and credentials into whether they need protection from the government is far more likely to indicate financial sophistication than a blanket financial threshold.

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