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The Accredited Investor Rule, created by the U.S. Securities and Exchange Commission (SEC) under Rule 501 of Regulation D, decides who can invest in private markets. These markets include things like private equity, venture capital, and hedge funds.

To qualify, individuals must have a high income or a lot of money, which keeps most regular investors out. This rule stops everyday people from getting access to investmentsthat could bring big returns, sparking a debate about fairness in private markets.

What Is The Accredited Investor Rule?

The Accredited Investor Rule identifies individuals and entities eligible to invest in private securities offerings, which are exempt from registration with the Securities and Exchange Commission (SEC). These investments, including private placements and venture capital, are often riskier and less transparent than public market securities. The SEC assumes accredited investors have the financial acumen or resources to evaluate and withstand the risks without needing the protections of registered offerings.

Key Criteria For Individuals

To qualify as an accredited investor, an individual must meet one of the following:

• Income Threshold: An annual income exceeding $200,000 (or $300,000 combined with a spouse or spousal equivalent) for the past two years, with a reasonable expectation of the same in the current year.
• Net Worth Threshold: A net worth over $1 million, individually or with a spouse or spousal equivalent, excluding the value of their primary residence.
• Professional Certifications: Holding certain professional licenses, such as FINRA Series 7, Series 65, or Series 82, in good standing, as added in the 2020 SEC amendments.
• Knowledgeable Employees: Being a “knowledgeable employee” of a private fund, such as directors or employees involved in the fund’s investment activities, for investments in that fund.

Criteria For Entities

Entities, such as trusts, corporations, or family offices, can also qualify if they meet specific requirements, such as:

• Assets exceeding $5 million (e.g., for limited liability companies or family offices).
• Owning investments over $5 million (e.g., for Indian tribes or foreign entities), as defined under the Investment Company Act.
• All equity owners being accredited investors (e.g., for certain partnerships).

Why Does The Rule Exist?

The rule stems from the SEC’s mission to protect investors. Private securities lack the disclosure requirements of public companies, making them riskier and harder to evaluate. The SEC assumes accredited investors, due to their wealth, income, or expertise, can “fend for themselves” without regulatory safeguards. This framework allows startups and private funds to raise capital more efficiently while limiting exposure to less experienced investors who might not understand the risks.

However, the rule also creates a trade-off. It grants wealthier or professionally qualified individuals access to potentially lucrative opportunities, like early-stage startup investments, while excluding others, raising concerns about fairness and access to wealth-building opportunities.

How Have The Rules For Accredited Investors Changed?

The SEC first created the rules for accredited investors after the Great Depression, as part of the Securities Act of 1933. The last big update to these rules was in 1982, when private funds were still a new type of investment and didn’t play as big a role in the U.S. economy as they do now.

For almost 40 years, the SEC used just two main factors to decide who could be an accredited investor: how much money they made or how much they were worth. These limits stayed the same, even though prices went up over time due to inflation.

The only change came in 2010 with the Dodd-Frank Act, which said that a person’s home shouldn’t count toward their total wealth. But aside from that, things stayed pretty much the same until 2020. In 2020, the SEC made changes to allow more people to invest in private deals by considering their financial knowledge and experience, not just their income or wealth.

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What’s Coming Next For The Accredited Investor Rule?

The SEC's Role

The SEC is responsible for deciding who qualifies as an accredited investor. In 2021, the SEC said it might revisit the financial requirements for individuals. Many expect the SEC to raise the income and wealth limits that were set back in 1982 to account for inflation. If this happens, fewer people would qualify as accredited investors.

However, not everyone agrees with raising these limits. Republican SEC Commissioners Hester Peirce and former Commissioner Elad Roisman criticized the idea. The SEC’s Small Business Advisory Committee also recommended keeping the current limits.

They argue that higher limits would hurt communities with lower incomes and living costs. It could mean fewer investment opportunities for people in those areas and make it harder for new businesses and entrepreneurs to get funding. It could also create extra hurdles for entrepreneurs from underrepresented groups.

Congress's Role

Congress has the final say and can override any decision made by the SEC. For example, Congress could pass a law to lock in the current income and wealth limits. In May and June 2023, the House of Representatives took steps in this direction. They passed three bills: the Accredited Investor Definition Review Act, the Fair Investment Opportunities for Professional Experts Act, and the Equal Opportunity for All Investors Act.

Together, these bills aim to keep the current income and wealth limits, create more ways for people to qualify based on their knowledge, and require the SEC to design a test to measure an investor’s understanding. Those who pass the test could then qualify as accredited investors and invest in private assets.

How Retail Investors Are Locked Out Of Private Markets

Private Markets Are Mostly For The Wealthy

Private markets include things like private equity, hedge funds, and venture capital. These types of investments are usually only available to a select group of people called accredited investors.

Accredited investors are often wealthy individuals or large organizations like pension funds. This means that regular middle-class people, also known as retail investors, are generally not allowed to invest in these markets unless they meet very strict wealth requirements.

A System That Favors The Rich

This setup creates a kind of gatekeeping based on how much money someone has. Only those who are already rich can get access to investment opportunities that have the potential for high growth. Examples of these opportunities include early-stage startups or exclusive investment funds. Because of this system, retail investors are left out and cannot participate in these potentially lucrative investments.

Missing Out On Big Opportunities

One example of what retail investors miss out on is investing in pre-IPO tech companies. These are technology companies that have not yet gone public but are valued at over a billion dollars, often called unicorns.

Historically, these kinds of investments have provided very high returns. However, they are only available to venture capital firms and individuals who have a lot of money. This leaves retail investors without the chance to benefit from these kinds of high-return investments.

The Unequal Playing Field - Is It Still Justified?

The rule for accredited investors makes economic inequality worse by favoring the wealthy. Just because someone is rich doesn’t mean they understand finances, but the rule assumes wealthy people are automatically smart about investments. Instead of just looking at wealth, it might be fairer to use tests or experience to decide who can handle risky investments.

For example, regular people were not allowed to invest early in companies like Uber or Airbnb, which later made huge profits for wealthy investors. Critics say this creates a pattern where the rich keep getting richer, while everyday investors are stuck with fewer opportunities to grow their money.

Possible Reforms And Alternatives

Changing the rule could include implementing a merit-based system for accreditation, where individuals are required to complete investor education programs or earn certifications instead of simply meeting wealth-based criteria. A tiered access approach could be introduced, allowing everyday investors to take part in private investments that carry lower risks, depending on their level of knowledge and their ability to handle risk.

For example, someone who completes a financial literacy course approved by the SEC could be granted limited access to private investment opportunities. Striking a balance between protecting investors and enabling broader participation is crucial - rules that are too lenient could lead to fraud, while rules that are too restrictive can limit opportunities. Pilot programs that test these alternative approaches could provide valuable insights to help shape more effective and fair regulations.

Who Benefits From The Status Quo?

The current system mostly helps big institutions, rich people, and managers of private funds. Accredited investors get special access to investments that often bring high returns, while fund managers make a lot of money from high fees because there isn’t much competition.

By keeping most people out, the rule keeps money flowing only among the wealthy few. This setup also means private funds don’t have much reason to come up with new ideas or lower their costs. Since the system works well for those in charge, they have no real reason to push for changes.

The Future Of Private Market Access

Shifts toward decentralization and financial inclusion are transforming the way people invest. Technologies like blockchain and asset tokenization have the potential to make private markets more accessible by breaking down investments into smaller pieces.

This would allow regular investors to purchase tiny shares in private funds or startups, something that was previously out of reach. The SEC is gradually adapting, with ongoing conversations about updating Regulation D to keep up with these changes.

At the same time, technology could improve safeguards for investors, such as through the use of smart contracts that ensure transparency and accountability. While there are still risks involved, these advancements point to a future where private markets could become both safer and more open to a wider range of participants.

Frequently Asked Questions

What Are The Rules For Being An Accredited Investor?

An accredited investor should have a net worth exceeding $1 million, either individually or jointly with a spouse. This amount cannot include a primary residence. The offers that appear in this table are from partnerships from which Investopedia receives compensation.

Who Verifies An Accredited Investor?

Rather than providing specific documentation supporting your income or assets, you can provide a letter from one of the following licensed third-party verifiers: CPAs, Attorneys, or licensed professionals holding either FINRA Series 7, 65, or 82 licenses.

Can A Non-US Person Be An Accredited Investor?

Note that you will need to meet US accreditation standards even if you are not a citizen or resident of the US. Documents must be in English. We recommend obtaining a third-party accreditation attestation (see option 3) if your documentation cannot be translated.

Can I Invest If I Am Not An Accredited Investor?

Being a non-accredited investor does not mean that the individual cannot invest; however, investment opportunities for them are different from accredited investors. The options available for non-accredited investors include certain types of bonds, real estate, equities, and other securities.

Do I Need To Be An Accredited Investor To Invest In A Startup?

If you want to invest in startups without being accredited, you can explore Regulation Crowdfunding (Reg CF) offerings. The Jumpstart Our Business Startups (JOBS) Act of 2012 allowed more individuals the opportunity to invest in certain early-stage capital raises.

Final Words

The accredited investor rule sets up a system that keeps everyday investors out of private markets, where they could potentially earn high returns. This helps continue the gap between the rich and everyone else.

More and more people are calling for changes to this rule as part of a larger movement toward making finance fairer for everyone. This push is supported by new technology and changing public attitudes. While it’s important to protect regular investors, they shouldn’t be shut out of opportunities altogether.

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