In October 2014, the SEC’s Investor Advisory Committee (IAC) recommended significant changes to the definition of “accredited investor” which are still pending. If adopted, these changes will have a big impact on private stock offerings.
Why It Matters
It’s been a year since the SEC issued final regulations lifting the 80-year-old ban on general solicitation and general advertising (GSGA) for private placements. Subject to certain restrictions, issuers may now use their websites, social media, and e-mail — as well as traditional print and broadcast print advertising — to promote stock offerings without the need for a registered public offering.
Although many issuers have taken the opportunity to reach a wider audience of potential investors, the use of GSGA hasn’t caught on as quickly as predicted. One reason for this is that sales pursuant to these offerings are limited to accredited investors. And issuers must take “reasonable steps” to prevent sales to non-accredited investors, including verification of purchasers’ net worth and income. This may be a burden on issuers and may deter potential investors who are hesitant to share their sensitive financial information.
Issuers still have the option of conducting private offerings without GSGA. This enables them to sell stock to an unlimited number of accredited investors plus up to 35 non-accredited investors who, either alone or with a purchaser representative, are considered “sophisticated.” Also, in offerings without GSGA, an issuer has less responsibility for verifying an accredited investor’s qualifications. Investors essentially “self-certify” by completing a questionnaire and demonstrating a pre-existing relationship with the issuer.
What’s Being Proposed
Under the current definition, individual investors are accredited if they have either:
1. Net worth of at least $1 million (excluding their primary residence), or
2. Income of at least $200,000 ($300,000 for married couples) in each of the preceding two years which is expected to continue in the current year..
People with this level of income or net worth are considered to be better equipped to make informed investment decisions and protect their own interests.
However, the IAC has stated that “the current definition [of “accredited”] is, at best, an imperfect proxy for financial sophistication and access to information.” Investors with high income or net worth aren’t necessarily sophisticated, and many highly sophisticated investors under the income thresholds are excluded. Plus, the definition doesn’t take into account the liquidity of a person’s net worth or the percentage of income or net worth being invested.
To address these deficiencies, the IAC recommends:
• Revising the definition of accredited investor to allow individuals to qualify based on their financial sophistication measured by professional credentials, investment experience, or a standardized test, and
• If income and net worth thresholds continue to be used, limiting investments to a percentage of income or assets.
The committee also suggests strengthening protections for non-accredited investors who are deemed sophisticated based on advice from a purchaser representative (such as prohibiting representatives from having a personal financial stake in an investment). And it urges the SEC to develop alternative means of verifying accredited status that eases the burden on issuers and avoids the need for investors to share sensitive financial information with issuers. One potential solution is to use independent third parties — such as brokers, investment advisers, accountants, or attorneys — to verify accredited investor status.
Expanding the Pool
Issuers should monitor the SEC’s deliberations over the IAC’s recommendations. The suggested changes are likely to improve investor protection while expanding the pool of capital available for private offerings.