Have you ever wanted to invest in a hedge fund? Or participate in a crowdfunded real estate investment opportunity? To take advantage of these and many other alternative investment opportunities, you'll probably need to meet the Securities and Exchange Commission’s (SEC) definition of an accredited investor.
Traditionally, an individual could only qualify as an accredited investor based on their financial resources, but the SEC just made some big changes to the accredited investor definition that could open the door to these investments for a wider pool of investors.
What is an accredited investor?
By definition, an accredited investor is an individual or entity with a certain level of financial sophistication. Investors who meet the SEC's definition of an accredited investor have access to certain investment opportunities that aren't available to the general public, such as hedge funds and other private fund investments as well as most private equity commercial real estate (CRE) deals.
For individuals, the definition of accredited investors has been based on financial resources. To qualify as accredited, an individual must have at least $1 million in net worth, excluding their primary residence, or they must have annual income of $200,000 ($300,000 in joint income with a spouse) for the past two consecutive years with an expectation of the same in the current year.
There is also a list of entities that qualify as accredited investors. For example, a trust with assets of $5 million or more would qualify.
Why do we have accredited investor rules?
So why are there accredited investor rules in the first place? The short answer is for investor protection.
Think of it this way. When you invest in a common stock on the New York Stock Exchange (NYSE) or Nasdaq Stock Market, the companies you invest in have to jump through many regulatory hurdles before their stocks can be listed on the exchange. They have to submit regular financial statements and report other valuable information. So, while stocks can certainly lose money, there are some major steps taken to protect investors from scams and from generally being misled, which is why the SEC feels safe letting a non-accredited investor participate.
On the other hand, when it comes to private equity investments, hedge funds, unregistered securities, and crowdfunded real estate investment opportunities, this isn't the case. Investors are largely left to do their due diligence on their own, so the accredited investor status is there to make sure investors have at least a minimal level of financial sophistication to be able to make wise investment decisions.
What just changed?
Obviously, the accredited investor rules aren't perfect. Surely there are investors with less than $1 million in assets who are firmly in the "sophisticated investor" category and understand how to evaluate private equity real estate investments, just to name one example. Conversely, there are plenty of millionaires out there who have no business trying to evaluate such an investment.
As a result, the SEC made several changes to the definition of an accredited investor, namely:
- The definition now allows individuals to qualify based on their professional credentials or certifications, as opposed to simply requiring a minimal amount of net worth. Initially, this includes individuals who have obtained Series 7, Series 65, or Series 82 licenses, but the amendment makes clear that additional credentials can be added in the future.
- Individuals who are "knowledgeable employees" of a private fund can now be included as accredited investors.
- Limited liability companies (LLCs) with $5 million in assets can be considered accredited investors.
- SEC- and state-registered investment advisors, exempt reporting advisers, and rural business investment companies (RBICs) are added to the list of entities that qualify as accredited investors.
- Any entity that owns investments worth $5 million or more, such as an Indian tribe or government body, can be considered an accredited investor.
- Family offices with at least $5 million in assets under management are now accredited investors.
- The term "spousal equivalent" has been added to the accredited investor definition, so if one spouse of a married couple qualifies based on their finances, the other can as well.
The bottom line
The key takeaway is that the changes broaden the definition of "accredited investor" to base an investor's level of sophistication on more than just their personal wealth.
These amendments will have implications for many areas of the investment world. Investment vehicles like crowdfunded real estate, hedge funds, private equity, and more will be available to a larger pool of potential investors.