Rule 506 of Regulation D allows for sales by private companies to an unlimited number of “accredited investors” and, for offerings that do not involve general solicitation, to a limited number of sophisticated non-accredited investors. The definition of who qualifies as an “accredited investor” under Rule 506 of Regulation D has long been questioned. Detractors are quick to question whether the current definition effectively defines the class of individuals who are capable of fending for themselves. In October the SEC Investor Advisory Committee took a big step towards revising the current definition. The committee recommended considerable changes to the Securities and Exchange Commission, saying it should broaden the potential accredited investor pool and strengthen verification that potential investors qualify as an accredited investor. Any changes would seriously impact startups, investors and all of those individuals who are involved with early stage companies and emerging businesses. The recommendations made by the SEC Investor Advisory Committee are set forth below:
Recommendation 1
The Securities and Exchange Commission should carefully evaluate whether the accredited investor definition, as it pertains to natural persons, is effective in identifying a class of individuals who do not need the protections afforded by the ’33 Act.
Recommendation 2
The Securities and Exchange Commission should revise the definition to enable individuals to qualify as accredited investors based on their financial sophistication. If this position were to be adopted, it would make sense to consider a wide variety of criteria such as professional experience and professional licenses.
Recommendation 3
If the Securities and Exchange Commission chooses to continue with an approach that relies exclusively or mainly on financial thresholds, the SEC should consider alternative approaches to setting such thresholds – in particular limiting investments in private offerings to a percentage of assets or income – which could better protect investors without unnecessarily shrinking the pool of accredited investors.
Recommendation 4
The Securities and Exchange Commission should take concrete steps to encourage development of an alternative means of verifying accredited investor status that shifts the burden away from issuers who may, in some cases, be poorly equipped to conduct that verification, particularly if the accredited investor definition is made more complex.
Recommendation 5
In addition to any changes to the accredited investor standard, the Securities and Exchange Commission should strengthen the protections that apply when non-accredited individuals, who do not otherwise meet the sophistication test for such investors, qualify to invest solely by virtue of relying on advice from a purchaser representative. Specifically, the Committee recommends that in such circumstances the SEC prohibit individuals who are acting as purchaser representatives in a professional capacity from having any personal financial stake in the investment being recommended, prohibit such purchaser representatives from accepting direct or indirect compensation or payment from the issuer, and require purchaser representatives who are compensated by the purchaser to accept a fiduciary duty to act in the best interests of the purchaser.
Under the Dodd-Frank financial reform law, the SEC must review the accredited investor definition every four years. This is the first such required review since Dodd-Frank was enacted in 2010. As you can see these recommendations are very high level and it remains to be seen if any changes are implemented by the SEC as a result. Nonetheless, it could be the impetus that leads to several revisions to the definition of an “accredited investor”, but a complete overhaul of the definition is likely unrealistic.
These recommendations along with the committees rational can be viewed at the following link: http://www.sec.gov/spotlight/investor-advisory-committee-2012/accredited-investor-definition-recommendation.pdf