Significant Changes to SEC Accredited Investor Definition

Your Solo 401k provides a wide range of possible investment opportunities. However, the one government regulation still limiting some investment opportunities is SEC Rule 144A. The rule prevents some investors from participating in private placements (also known as non-public offerings). Individuals allowed to participate in these private placements are known as “accredited investors.” On August 26, 2020, the SEC made a significant rule change to the definition of an “accredited investor.”

“For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication.”

~SEC Chairman Jay Clayton

Accredited Investor Options for Placing Funds

Examples of some investments historically  limited to accredited investors include:

• Private hedge funds
• Many private equity investments
• Venture capital funds
• Angel investments
• Other private placements

To protect the investor, the SEC requires disclosure of certain investment information in most public offerings. On the contrary, private funds and offerings do not have to make the same level of disclosures. For example, many hedge funds do not disclose their exact portfolio make-up. This gives them a competitive advantage. But, with less transparency comes a greater need for sophisticated investors. That’s because the investor should understand the risks associated with the investment. Historically, this limits private investments to accredited investors.

As an accredited investor, the SEC considers you more sophisticated (after all, you’re at a higher wealth level). As such, the SEC believes you have a greater tolerance for risk. Additionally, the SEC believes you have a greater capacity for due diligence.

But exactly what does accredited investor now mean under the SEC changes and how do you know if you qualify? Let’s begin with a little history.

Financial Sophistication Used to be All About Existing Wealth

Banks, insurance companies, and pension plans must meet various regulatory standards to qualify for some investments not regulated by the SEC. The SEC expects these institutional investors to have a certain level of sophistication. As such, they can properly due diligence an investment, and assess the risks associated.

Previously, the only way for an individual to qualify for certain investments was as an accredited investor. To be an accredited investor, you must meet certain wealth thresholds.

Previous to the August 2020 change, the definition of an “accredited investor” was only based on these two wealth thresholds.

1. Earned income of more than $200,000 ($300,000 together with a spouse) in each of the last two years. You must reasonably expect to earn the same for the current year.-or-

2. Has a net worth over $1 million, either individually or together with a spouse. This net worth requirement excludes the value of your primary residence.

Meeting the wealth-based threshold will still qualify individuals as accredited investors. However, the new SEC rules now provide an alternative method to qualify. This updated definition no longer requires a wealth accumulation minimum prior to investing. We’ll get to those important changes in a moment. However, if you can prove that you meet these financial hurdles, you can still qualify as an accredited investor.

Accredited Investor Qualification Updates

These financial hurdles aren’t adjusted for inflation. They aren’t connected to any index that makes periodic adjustments to the dollar amounts. Instead, the SEC includes the dollar amounts in the law itself. The full and formal definition of accredited buyers (including institutions) is defined in §230.501 Definitions and terms used in Regulation D.

Historically, there was also an important change in 2012 under the Jumpstart Our Business Startups Act (JOBS Act). Although not directly related to accredited investors, it did make it possible and easier for non-accredited investors to invest in certain alternative investments through crowdfunding platforms.

As with any Solo 401k investment, if you go this route, be sure you title the investment in the name of your Solo 401k trust and use your Solo 401k tax ID number. Sign the investment documents as the trustee of the 401k plan. Initiate the investment using funds from your Solo 401k bank account and receive any dividends, gains, or disbursements right back into your Solo 401k bank account.

The Big Changes in the SEC Definition of an Accredited Investor

There were two significant SEC changes to defining an accredited investor. One broadened how to apply the wealth calculation. The wealth calculation now includes the term “spousal equivalent”.  This means that if one spouse qualifies as an accredited investor, that person’s spouse does also. The other change provides a path to accreditation that is no longer solely based on already accumulated wealth.

Notably, there are now other ways to qualify as an accredited investor. Individuals can now qualify as an accredited investor based on certain professional credentials or certifications. Currently, the new definition includes those who have obtained Series 7, Series 65, or Series 82 investment securities licenses. State or SEC-registered investment advisors also qualify. Most investors expect the list of qualifying licenses to continue expanding.

These may still seem like unreasonable burdens for meeting the SEC requirement of an accredited investor. Right or wrong, the SEC concludes that accredited investors be more financially sophisticated than the average person. The backbone of this logic is that a person that obtains a Series 65 license has demonstrated the ability to independently analyze investment opportunities. Probably more important to the SEC logic is that accredited investors have significant financial resources and can afford losses on investment opportunities that don’t work out.

How to Become an Accredited Investor

There is not a government or independent body defined “process” for becoming an accredited investor. There is no certified exam or piece of paper issued stating a person meets the accredited investor status. The verification process is for the companies issuing unregistered securities to determine a potential investor’s status. They do so by conducting due diligence on the investor prior to allowing incoming funds. Each time an investor purchases unregistered securities, the due diligence must be conducted by the company making the offer at that point in time. But once you go through the process, you’ll generally know what to expect will be required in the future.

For the wealth-based qualification, expect to provide detailed financial information. This includes W-2s, tax returns, bank and brokerage statements. These statements should demonstrate your current net worth is more than $1 million. Remember, your primary residence doesn’t count toward net worth requirements. Alternatively, prove your income in the past two years meets the qualification threshold. You might also use an Accredited Investor Letter. Typically, your attorney and/or CPA verifies your assets proving you meet accredited investor status.

Your Solo 401k can play an important role in this qualification. Generally, if you are the trustee of your Solo 401k and your combined assets (Solo 401k plus personal assets) meet the $1 million threshold, both you and the Solo 401k should qualify as accredited investors.