What is an Accredited Investor?

Introduction

A company offering securities must register its offerings with the Securities and Exchange Commission (SEC) unless it meets an exemption. One exemption is Rule 506 of Regulation D, which allows a company to sell its securities to so-called “accredited investors” without registering the offerings with the SEC.

Rule 501 of Regulation D defines the term “accredited investor.” To be considered an accredited investor, you must meet the following criteria:

· Individuals must have an annual income of $200,000 over the last two years (or for couples, an annual income of $300,000 over the last two years), as well as “a reasonable expectation of reaching the same income level in the current year” OR

· A net worth of over $1 million, not including one’s personal residence

Image Credit: https://www.finra.org/media/image/14143

How does this manifest itself in practice? Let’s look at some calculations.

Since the 1980s, there has been a ten-fold increase in private placement investments. Around 16 million households are accredited investors, according to a September 23, 2018 article in the Wall Street Journal. This does not necessarily mean that more households are qualified to engage in risky investments, however. Instead, the criteria for becoming an accredited investor has remained unchanged since 1983. If the criteria had evolved with inflation, an individual would now need to make $515,000 annually, not $200,000. Their net worth would have to be $2.5 million, not $1 million. Because so many more Americans can qualify as accredited investors, in 2017 alone, 1,200 brokerage firms sold more than $710 billion in private placements. Reg. D offerings have benefits, but they also carry many serious risks that could substantially outweigh any potential gains.

Why Become an Accredited Investor: The Potential Benefits of Reg. D Offerings

Why would someone want to become an accredited investor? What opportunities are accredited investors afforded? Accredited investors can invest in private placements (also known as “Reg. D offerings”). These securities carry a potential for high returns, but they are high risk. Investors could even lose their whole investment. Thus, investors need to be able to “fend for themselves,” according to the SEC’s Office of Investor Education and Advocacy

Why Not to Become an Accredited Investor: The Risks of Reg. D Offerings

Fraud is rampant among broker-dealers that issue private placements, and the numbers bring this issue into stark relief. According to publicly-available BrokerCheck records, brokerage firms selling private placements have a median of 15.38 complaints and regulatory actions per 100 brokers, five times more than firms that do not sell private placements, reports the Wall Street Journal. While only around 40% of brokerages sell private placements, these brokerages account for more than half of the 94 firms that FINRA has expelled from the securities industry since 2013. Furthermore, firms selling private placements are 1.4 times more likely to have been expelled from the securities industry by FINRA than firms that don’t sell private placements.

Due to the prevalence of fraud, even if you can qualify as an accredited investor, think twice about the investments you’re considering. Make sure you do your research. Companies and private funds (like hedge funds and venture capital funds) do not have to disclose certain information to accredited investors. Instead, investors have to do their own due diligence, which can be difficult — even with a high level of financial sophistication.

Questions to Ask

Before investing in private placements as an accredited investor, be sure to ask the following questions:

• Are the investments liquid or illiquid? Can they be bought and sold?
• Is the company financially sound?
• Will my broker receive a commission (or any other “perks”) for recommending this private placement to me? If so, how much will they receive?
• Have the finances of the company been audited? Does the auditor have a good reputation?

If you have invested in private placements and fear they may not have been suitable, think back and answer the following questions:

• Did my broker ask sufficient questions about my financial knowledge and net worth?
• Was I informed that I could lose my entire investment?

One third of accredited investors are retirees, who are particularly vulnerable to fraud and financial exploitation. Elderly investors should take particular care to ask questions before becoming an accredited investor and investing in Reg. D offerings/private placements.

Next Steps

If you have questions about accredited investors or Reg. D offerings, don’t hesitate to contact a securities attorney. Call (877) 238–4175, email info@fkesq.com, or visit www.stopbrokerfraud.com for your free case consultation with the securities attorneys of Fitapelli Kurta.