Washington, DC - In a new study released today, the General Accounting Office suggests adding new criteria to qualify accredited investors under Rule 506, Regulation D -- such as by looking at investors' "investment liquidity" and their use of registered advisers -- may be better alternatives to qualifying accredited investors than raising the current minimum net worth/income threshold. However, the GAO admitted that its input from market participants could not be "generalized" because of the small pool of participants the GAO surveyed for its study.
The GAO released the study "Securities and Exchange Commission: Alternative Criteria for Qualifying As an Accredited Investor Should be Considered," GAO-13-640," just eight days after the SEC implemented a JOBS Act requirement to lift a ban on general advertising made by business to potential accredited investors. As soon as Mid-September 2013, businesses may be able to offer private placements to accredited investors, when the new general solicitation rules is expected to take effect.
The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates GAO to study the criteria for qualifying individual investors as accredited. Also, beginning in 2014, the SEC must review the accredited investor definition every 4 years to determine whether it should be adjusted. In its study, the GAO determined that the intended purposes of the accredited investor standard are to (1) protect investors by allowing only those who can withstand financial losses access to unregistered securities offerings and (2) streamline capital formation for small businesses. To qualify as accredited, SEC requires an investor to have an annual income over $200,000 ($300,000 for a married couple) or a net worth over $1 million, excluding a primary residence. The thresholds were set in the 1980s and 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates GAO to study the criteria for qualifying individual investors as accredited.
The GAO found that raising the minimum threshold standard for an accredited investor likely would decrease the number of qualifying investors nationwide. "Others noted that some parts of the market might not accept adjustments to the thresholds," the GAO reported. "For example, an association of angel investors—accredited investors who invest in start-up companies—told GAO that they would be resistant to increased thresholds because it would decrease the number of eligible investors. GAO analysis of federal data on household net worth showed that adjusting the $1 million minimum threshold to approximately $2.3 million, to account for inflation, would decrease the number of households qualifying as accredited from approximately 8.5 million to 3.7 million. "
Among the financial resources criteria, market participants with whom GAO spoke most often identified a liquid investments requirement--a minimum dollar amount of investments in assets that can be easily sold, are marketable, and the value of which can be verified--as the most important for balancing investor protection and capital formation. Among the understanding financial risk criteria, market participants most often identified the use of a registered investment adviser. "[The] SEC should consider alternative criteria for the accredited investor standard. For example, participants with whom GAO spoke identified adding liquid investments and use of a registered adviser as alternative criteria," the report concluded.
Observers, however, found striking that the GAO relied on a small pool of participants for the study. The report points out:
The GAO categorized in four groups of different segments of the accredited investor population: (1) attorneys who have experience in private placement transactions, (2) accredited investors who invest in private placements, (3) retail investors who meet the current accredited investor criteria but do not necessarily invest in private placements, and (4) broker-dealers and investment advisers who work with accredited investors. The report observes, "The results from the structured interviews are not generalizable to the population of market participants and only represent the opinions of these 27 individuals."
Summary by A. Brian Dengler. Photo courtesy ShowBiz_Kids on Flick.com under Creative Commons License.