August 26, 2020- The Securities and Exchange Commission (the “SEC“) today took an initial step towards democratizing access to private investments by expanding the definition of an “accredited investor” to include persons who have demonstrated certain levels of financial sophistication. Qualifying as an “accredited investor” is important because it is a regulatory prerequisite to participation in private investment opportunities, including private equity, hedge funds, venture funds, start-ups and real estate.
Historically, “accredited investor” categories were limited to those persons or entities that maintained a certain level of net worth, income or investments. While the focus on these particular attributes ensured investors in the riskier private markets were able to sustain potential losses, it also unnecessarily prohibited individuals and entities with high levels of financial sophistication (but low wealth) from participating. In adopting the final rules, SEC commissioner Hester Peirce specifically flagged that the pre-existing standard unjustifiably “discriminates against financially sophisticated, lower income and net worth Americans.”
The final rule expands the “accredited investor” definition to include persons who maintain certain designations administered by the Financial Industry Regulatory Authority, Inc. (“FINRA“). Specifically, any Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65) or Licensed Private Securities Offerings Representative (Series 82) holder will now be considered an “accredited investor.”
The SEC hinted that this initial expansion may simply be the first step in broadening the “accredited investor” categories even further. These initial categories are to serve as a test case for adoption, with the SEC reserving the right to expand the qualifying licenses to include “other certifications, designations, or credentials…that are consistent with the specified criteria and that the [SEC] determines are appropriate.”
This welcome change in the “accredited investor” definition comes as private markets have grown from an esoteric corner of the financial ecosystem thirty years ago into the dominant investing category in the world. Sophisticated investors (including pension funds, sovereign wealth funds, family offices, angel investors and private equity funds) have increasingly moved into private markets, attracted by the higher yielding assets available there. With this rule change, investors with lower income or wealth will have increased access to these same opportunities.
While FINRA licensing opens the door to a larger number of potential investors, it nevertheless remains difficult for otherwise qualified persons to receive sponsorship for an exam. Additional credentialing options for persons wishing to participate in the private capital markets, including potentially making FINRA examinations more open to the public, would be a great next step in democratizing access to private investments.
In addition to the new categories of natural person “accredited investors” and certain definitional changes, the final rule clarifies that certain entity types with sufficient assets, including family offices, Indian tribes, governmental bodies and limited liability companies, are also included as “accredited investors.” All changes in the final rule go into effect 60 days after posting in the Federal Register.