Statement on Modernization of the Accredited Investor Definition
Aug. 26, 2020
Today, the Commission adopted final rules to modernize and add much needed flexibility to the definition of “accredited investor” by adding new categories of qualifying individuals and entities that have demonstrated financial sophistication such that they should not be excluded from the very large, multifaceted and important private capital markets. The private capital markets are important to investors and issuers of various types, as well as our economy more generally. The accredited investor definition is the principal test for investor participation in significant segments of our private capital markets. It also plays an important role in other state and federal securities law contexts.
The test for individuals to qualify as accredited investors has largely remained unchanged for over 35 years. This test relies exclusively on a person’s income and net worth. If you make enough money or have sufficient assets, you are eligible to participate, and if you do not, you generally are not eligible. The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess and bear risk has long been unsatisfactory. Individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks of participating in unregistered offerings, are denied the opportunity to invest in our private markets. For example, using only a binary test for wealth disadvantages otherwise financially sophisticated Americans living in lower income/cost-of-living areas.
Moreover, businesses – particularly smaller and early stage businesses, those in geographic areas with lower concentrations of accredited investors, or founders without a wealthy friends-and-family network – are unable to seek investments from otherwise financially sophisticated individuals to access much needed seed and growth capital. When small and medium-sized businesses often, and increasingly, rely on local sources of capital, particularly at the seed and initial growth stages, these restrictions are limiting and almost certainly stifle opportunity. It has been noted that these wealth-based limits on opportunity can have a disproportionate impact on minority- and women-owned businesses and other underrepresented founders.
With respect to the Commission’s updates for institutional investors, we have received broad, almost universal support for our modernization efforts, including our long overdue recognition of tribal governments, governmental bodies, and family wealth management vehicles as sufficiently sophisticated to participate in the private markets. In light of that support, I will focus the remainder of my comments on the individual investor test and a few issues that have been raised.
We are expanding the definition of accredited investor to include an alternative to the wealth test for natural persons — specifically, persons who hold certain professional certifications and designations and other credentials from accredited educational institutions. The Commission will be able to designate these by Order based on a number of criteria. The initial certifications include the Financial Industry Regulatory Authority, Inc. (FINRA) Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82) certifications. There is no doubt persons who have successfully obtained these certifications – and maintained them in good standing – are sufficiently financially sophisticated to participate in the private markets.
During the notice and comment period, there have been several criticisms of these modest, incremental efforts to modernize our accredited investor rules that I would like to address. It has been suggested that expanding the accredited investor definition to include these clearly sophisticated persons will result in more private financings. Some think this is a positive development, some think it is negative. When you look more closely, and in particular recognize that there are many segments in the private markets and many types of private financing, it is only positive. Any expansion in private financing due to these amendments, given the limited nature of the expansion of the accredited investor definition, is likely to be most meaningful in the area of small, local business financing. Adding clearly financially sophisticated persons to the pool of persons eligible to participate in these financings is a laudable and unassailable policy goal. Of course, many have asked us to go much further in expanding the pool of eligible investors, citing, for example, the wealth gaps faced by underrepresented founders and the importance of improving access to capital for underserved businesses and communities. A number of commenters on the Commission’s efforts in the private markets space have noted that women, minority and other underrepresented entrepreneurs, as well as those outside of the coastal urban areas where traditional venture capital investment has been more focused, often do not have an existing network of wealthy friends and family and, as result, struggle to access capital. Our Small Business Capital Formation Advisory Committee continues to explore how we might better serve these important segments of our markets. These are important issues to consider, and I hope that our Small Business Capital Formation Advisory Committee and our Investor Advisory Committee will continue to aid the Commission in seeking improvements to the definition and other areas of regulation that will enhance access to capital in these areas.
Some have claimed that the expansion of the definition somehow will result in more large private financings and, as a result, fewer public companies. An “upper bound” analysis of the relative potential economic impact, i.e., the potential amount of capital newly available, demonstrates this claim is unsupportable. Simply stated, the change in the definition will provide clearly sophisticated individual investors with more opportunities to invest and to diversify their investment portfolios, but it will not substantially affect aggregate capital flows among participants in private and public markets. I note here that we remain committed to, and have pursued and are continuing to pursue, measures to increase the attractiveness of our public capital markets for investors and issuers.
Finally, some argue that we should increase the wealth test thresholds because, with the passage of time, the regulatory value of these thresholds have been eroded and, as a result, less sophisticated investors are eligible to participate in the private capital markets. Others claim the current thresholds are unduly restrictive and that it is unfair to exclude people based on a binary wealth test. Together, these arguments speak loudly to why the current thresholds as the sole determination for participation in these markets are unsatisfactory. It is not clear that, for example, persons with $1.5 million in net worth are any more financially sophisticated than persons meeting the current $1 million threshold or persons with $500,000 or $50,000 in net worth. This point demonstrates why simply adjusting these thresholds is not the practical question we should be attempting to address. Instead, the practical question should be, how do we improve the system we have to more closely track our mission? We do just what we are doing: we add an alternative test that more accurately tracks the Commission’s policy goal — “to identify investors that have sufficient financial sophistication to participate in investment opportunities” in the private capital markets. We do not take the current unsatisfactory test and attempt to tweak it either (1) to exclude persons who currently are eligible or (2) to include additional persons based on a wealth test that many recognize does not, in itself, meaningfully track financial sophistication.
Finally, some of those who recognize that taking away the right of current participants in this market to continue to participate is inappropriate suggest exempting currently active accredited investors from the changes, i.e., trying to devise a system that applies one set of criteria to currently active accredited investors and a different, higher wealth/income standard to new investors. For various reasons, including the costs of tracking and verification, even if this approach were appropriate (and for the reason discussed here, I do not believe it is), it would be unworkable. In years to come, future Commissions, with the benefit of the additional means of demonstrating financial sophistication provided by today’s actions, may revisit the wealth tests and modify them with the knowledge that, given the alternative tests we are adopting today (which investors can over time take steps to satisfy), those modifications would be less disruptive and more fair to individual investors. However, today, we are not in that position. And here, I thank the staff and my colleagues for recognizing that modest, thoughtful updates that bring our rules more in line with our mission and long-standing policy objectives will have returns today and in the future, including by increasing the Commission’s ability to act as circumstances change. This is another fine example of retrospective review and modernization furthering each aspect of our tripartite mission.
 In 1988, the definition was modified to include a joint income component. Regulation D Revisions, Release No. 33-6758 (Mar. 3, 1988) [53 FR 7866 (Mar. 10. 1988)]. In 2011, the definition was modified to codify a statutory requirement to exclude the value of the investor’s primary residence from the calculation of net worth. Net Worth Standard for Accredited Investors, Release No. 33-9287 (Dec. 21, 2011) [76 FR 81793 (Dec. 29, 2011)].
 PitchBook, The Venture Climate, presentation at the Small Business Capital Formation Advisory Committee Meeting (Feb. 4, 2020), at 9, available at https://www.sec.gov/spotlight/sbcfac/2020-02-04-presentation-pitchbook-venture-climate.pdf; Catherine Mott, statement at the Small Business Capital Formation Advisory Committee Meeting (Nov. 12, 2019), at 74-75, transcript available at https://www.sec.gov/info/smallbus/acsec/sbcfac-transcript-111219.pdf.
 See e.g., Alicia Robb, Access to Capital among Young Firms, Minority-owned Firms, Women-owned Firms, and High-tech Firms, Small Business Administration Office of Advocacy (April 2013) (“African-American wealth levels are just 8 percent of non-minority wealth levels, and Hispanic wealth levels are just 12 percent of non-minority wealth levels.”)
 See letter from Southern Ute Indian Tribe dated Mar. 3, 2020 and Native American Finance Officers Association (NAFAO) dated Mar. 16, 2020. In addition, on July 18, 2019, prior to the Commission’s proposed amendments to the accredited investor definition, Chairman Clayton met with Dante Desiderio, Executive Director, NAFAO.
 See, e.g., letters from Brandon Andrews dated May 1, 2020 (noting the lack of equitable access to capital or investment opportunities for women and communities of color in the current Accredited Investor Definition) (available at Comments on Proposed Rule: Amending the "Accredited Investor" Definition, https://www.sec.gov/comments/s7-25-19/s72519.htm); NextSeed Securities LLC dated June 1, 2020 (“Often, underrepresented communities simply do not have the “pre-existing relationships” with accredited investors and do not know how to make those connections independently ...”), and OpenDeal, Inc. (d/b/a Republic) dated June 1, 2020 (“female, minority, veteran and immigrant entrepreneurs, as well as entrepreneurs based in middle America, often struggle to obtain exposure to and capital from traditional venture investors”) (both available at Comments on Proposed Rule: Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, https://www.sec.gov/comments/s7-05-20/s70520.htm). See also Arlan Hamilton, Investing in the Underestimated, 39th Annual Small Business Forum, June 18, 2020 (2020 Forum), transcript available at https://www.sec.gov/file/06182020-small-business-forum-transcript.pdf and the archived recording is available at https://youtu.be/G8m-kxH46wU (noting that broadening the accredited investor definition would lead to funding “more of these companies that are having so much trouble getting funding because of systemic biases”); Erica Duignan Minnihan and Samara Mejia Hernandez, Empowering Women Entrepreneurs, 2020 Forum (discussing the challenges that many women and minority founders face if they do not have an existing network of wealthy friends and family and the positive impact of expanding access to capital for female and minority founders to create change within diverse communities).
 See, e.g., Testimony on “Oversight of the Securities and Exchange Commission” Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, available at https://www.sec.gov/news/testimony/testimony-clayton-2019-12-10.
 In particular, I would like to acknowledge the following staff members for their contribution to this effort: From the Division of Corporation Finance: Bill Hinman, Michael Seaman, Betsy Murphy, Jennifer Zepralka, and Charlie Guidry. From the Division of Investment Management: Dalia Blass, Sarah Ten Siethoff, Melissa Gainor, Jennifer Songer, and Lawrence Pace. From the Office of the General Counsel: Bob Stebbins, Bryant Morris, Connor Raso, Cathy Ahn, and Natalie Shioji. From the Division of Economic and Risk Analysis: S.P. Kothari, Hari Phatak, Malou Huth, Vlad Ivanov, Lauren Moore, Andrew Glickman, and Mattias Nilsson.