The SEC Updated Their “Accredited Investor” Definition. This is why you should care.
Updated: Dec 6, 2021
Late in 2020, the Securities and Exchange Commission sent out an Amendment to Accredited Investor Definition. This directly affects the world of Syndications. Syndication funds are typically broken down into two SEC categories: 506(b) and 506(c) of Regulation D and fall under Section 4(a)(2) of the Securities Act. Although investors in both offering types receive “restricted securities,” the differences between the two are significant.
Let’s briefly review how the Securities and Exchange Commission defines them:
Rule 506(b) - These are called “Private Placements.” Companies conducting an offering under Rule 506(b) can raise an unlimited amount of money and can sell securities to an unlimited number of Accredited Investors. However, an offering under Rule 506(b) can only sell securities to no more than 35 non-accredited (sophisticated) investors. The offering (the real estate deal) is not allowed to be advertised (no general solicitation).
Rule 506(c) – These are called “General Solicitation.” Companies conducting an offering under Rule 506(b) can raise an unlimited amount of money and can sell securities to an unlimited number of Accredited Investors. However, no sophisticated investors are allowed to participate in these offerings. Rule 506(c) permits issuers to broadly solicit and generally advertise an offering, provided that all purchasers in the offering are Accredited Investors and the issuer takes reasonable steps to verify purchasers’ accredited investor status.
I know you know what it is, I'll define it for the other readers... not you. You got this!
The previous definition of an “Accredited Investor” was an individual with a net worth of at least $1Million (excluding the value of a primary residence) or annual income of at least $200,000 for the last two years (or $300,000 combined for married couples) with a reasonable expectation of reaching the same income level for the current year.
There were several challenges that this posed, such as investors that were borderline or unsure were excluded from 506(c) offerings and also would max out 506(b) Sophisticated Investor allotments.
Going into effect on December 9, 2020, the new definition went beyond these net worth and annual income thresholds and include defined measures of professional knowledge, experience or certifications. As a result, investors who are able to demonstrate a certain level of financial sophistication will be able to qualify for more syndication deals and ease the complexity of the 35-sophisticated rule.
In announcing the new accredited investor definition, the SEC said that it does not believe wealth should be the sole means of establishing financial sophistication for purposes of the accredited investor definition. “A person’s economic status may demonstrate an ability to withstand losses, but it certainly does not demonstrate financial sophistication. The accredited investor concept assumes that individuals cannot be trusted to exercise proper due diligence before making an investment decision and therefore bars individuals from having the investment opportunity in the first place,” stated Commissioner Hester M. Perice.
“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. A person’s economic status may demonstrate an ability to withstand losses, but it certainly does not demonstrate financial sophistication.”
The boring stuff behind us, here is a breakdown of the new methods relevant to real estate investing:
The SEC deems “natural persons” with specific certifications, licenses, and other credentials to be “financially sophisticated” enough to qualify as accredited investors. Accepted certifications from accredited educational institutions will initially include from The Financial Industry Regulatory Authority (FINRA):
Licensed General Securities Representative (Series 7)
Licensed Investment Adviser Representative (Series 65)
Licensed Private Securities Offerings Representative (Series 82).
"Knowledgeable employees" of venture capital or private equity funds would be permitted to invest in those particular funds without meeting the income or net worth tests typically required of accredited investors (as long as the fund identified as Accredited).
“Knowledgeable clients” of Family Offices.
An Accredited investor verification for an investor who previously invested with an Issuer is now good for a period of up to 5 years so long as “the investor provides a written representation that the investor continues to qualify as an Accredited investor and the Issuer is not aware of information to the contrary.”
The “spouse” definition has been amended to include non-married couples
The financial requirements didn’t change, which some view as a positive due to inflation. This rule has been in effect since 1982.
The SEC has left open the potential for added additional professionals to the knowledge pool.
We will be on the lookout for any new changes.
Instead of relying on existing relationships, we as syndicators and fund managers could now rely on more accredited investors. With the reduction of challenging onboarding of investors, less education would be required in the investment process, freeing up resources that could be allocated elsewhere.
The catch-22 is that if we did an exclusive 506(c) offering, that would go against our mission of inclusion. With more and more liquidity flowing into the real estate world, the potential for a massive funding opportunity is almost too hard to resist with these added accredited investor definitions.
For you the investor, the amended definition of Accredited Investor will open up more opportunities to continue to invest in alternative assets like our private equity funds. It can be especially beneficial to invest in alternative investments using a self-directed IRA instead of discretionary funds. Investment income and capital gains are tax-deferred if held in a traditional IRA, and they’re tax-free if held in a Roth IRA. However, they’re taxed at ordinary income tax rates if held in a taxable (or non-retirement) account.
As always, we are here to help. Feel free to reach out any time to discuss this further.
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We are Ten15 Capital, and we are innovating the world of real estate investing via apartment complexes. We create lucrative opportunities via syndication or joint venture projects.
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