SEC Potential changes to Accredited Investor definition raises concerns

Ostensibly to protect inexperienced investors from making ill-advised financial investments into real estate or other projects, the SEC has long set limits and conditions on the nature of investors who may be involved in such situations.

“Accredited Investor(s)” (“AI”) are often mentioned when real estate private equity investment projects are being discussed and it is changes to the rules relating to such investors which the SEC is currently focusing on.

However, before we look at some of the issues SEC may review, let’s just briefly discuss AIs.

Accredited Investors

An Accredited Investor is an individual or a business entity who/which is permitted to make certain types of investments, even though such investments may not be registered with financial authorities. An AI, typically, includes high net worth individuals (“HNWI”), banks, insurance companies, brokers and trusts.

As such investments are not registered and do not follow normal disclosure procedures, they are perceived to carry an inherently greater risk.

Therefore, regulatory authorities wish to ensure that AIs are experienced, financially stable, and knowledgeable about relatively risky ventures, thereby requiring lesser need for protection provided by regulatory disclosure filings

At present, the AI must meet certain requirements from relevant authorities: either regarding their income, net worth, asset size or governance status.

Relatively recent changes to the definition of an AI

In the recent past in the US (August 2020), the SEC made certain changes to the definition of an AI, with new regulations stating that they should be:

• individuals who have designated professional certifications or credentials;
• individuals who are employees of private funds with the appropriate industry related knowledge; or
• SEC- and state-registered investment advisers

Requirements to be an AI

In the US an Accredited Investor is defined under Regulation D of the Securities Act 1933 which states that an AI must:

• have income which exceeds $200,000 in each of the two most recent years (or $300,000 in joint income with a person’s spouse) and they reasonably expect to reach the same income level in the current year; or
• have a net worth which exceeds $1 million (individually or jointly with a spouse), excluding the value of their primary residence.
• be other persons approved by regulators.

Based on the above, about 13% of US households qualified as accredited investors in 2016, according to the SEC.

Currently contemplated changes

Following the changes in August 2020, the issue of what it means to be an Accredited Investors has resurfaced as private offerings continue to outpace SEC-registered public offerings. For example, in 2019, according to SEC data, private offering investment totaled $2.7 trillion, far outweighing the $1.2 trillion invested in registered offerings.

This is not the first time the SEC has been considering revamping the definition, according to Bloomberg Law. Yet it appears that this time is different in terms of the likely scale of the changes, with a much more robust approach possible.

At this time, the SEC is likely to start a review process again in April, beginning with requests for public comment on changing the definition of AIs who can participate in privately held, “unregistered” share offerings of at least $10 million.

However, such efforts to boost investor protection and disclosure by further redefining the status of an Accredited Investor may be counterproductive and potentially limit the pool of investors who can participate in certain types of private offerings.

This. in turn, could limit opportunities for investors from under-represented communities and contradict the Biden administration’s broader focus on diversity and equity. Furthermore, the inclusion of more people as eligible investors helps economic development, and enables them to enjoy returns on investment and wealth creation. This is important for certain groups of people who’ve been historically financially unable to invest in real estate, obtain loans and have good access to capital.

Specific possible changes

The SEC hasn’t yet clearly indicated which direction it will move in redefining Accredited Investors or whether it will raise the dollar thresholds for eligibility.

Some of the various options open to it (some promulgated by committed which advise the SEC, such as the Small Business Capital Formation Advisory Committee, include:

• redefine the definition of an AI, adding, for example, more details about investment experience, professional credentials, work experience, education, membership in an organized angel group, and/or a sophistication test;
• raise asset or income thresholds, periodically indexing the thresholds to inflation;
• leave the current financial thresholds in place, but possibly adjusting such thresholds downwards for residents in certain regions of the country;
• expand the definition in order to address diversity, equity and inclusion in capital markets and avoid exacerbating the wealth gap.

Some of the key concerns

Given that REPE attracts such a broad base of investors, whatever the SEC finally decides to do will, clearly, attract a variety of comments and, undoubtedly, some criticism. However, there are already several key viewpoints being expressed and suggestion made by the real estate private equity investment community and these include:

• increasing the minimum asset requirements is likely to exclude a large number of people, although, in reality, it may have a smaller impact on the actual amount of money available;
• an asset-requirement increase raises questions about equity and inclusion for communities which historically have faced barriers to participating in capital markets;
• on the other hand, major consumer protection and fraud concerns may arise if more people are allowed to invest in companies that aren’t subject to the SEC’s rigorous disclosure requirements for publicly traded companies;
• expanding disclosure requirements to more companies might be a better way to broaden the pool of investors to include those who’ve traditionally been excluded from securities markets.

CPI Capital partners with a number of AI as investors in our various multi-family PERE investments.

Passive private equity real estate investing is an ideal platform in which Accredited Investors may participate as they seek access to unique investment opportunities, strive to achieve their targeted returns and continue with their wealth creation

To unnecessarily restrict access to some non-registered investments or impose further limits on AIs appears unreasonable, especially as real estate development goes hand in hand with economic development, something which is good for everyone!

Yours sincerely

August Biniaz
CSO, COO, Co-Founder CPI Capital