What is an Accredited Investor?
An accredited investor refers to an individual or institutional investor who has met certain requirements set by the U.S. Securities and Exchange Commission (SEC). Accredited investors are allowed to purchase securities that are not available to other investors and that have not been registered with any regulatory authority.
The SEC requires such an investor to meet certain requirements, which include net worth, annual income, or professional experience. Typically, accredited investors include high-net-worth individuals, investment banks, etc.
In the United States, securities must be registered with the SEC before they can be offered for sale to the public. The SEC provides an exemption to certain securities that the issuers plan to sell to accredited investors. Such securities are unregistered, but the issuer must verify that the potential accredited investors meet requirements set by the SEC.
The registration process for securities is usually expensive. By being exempted from the registration process, companies can save a lot of money. Due to the high risk involving unregistered private placements, financial authorities like the SEC must verify such transactions and ensure investors are experienced and financially stable enough to engage in such investments.
Requirements to Become an Accredited Investor
The specific requirements for an individual or institution to become an accredited investor vary from one country to the other. For example, the United States, Canada, and the United Kingdom all impose different requirements.
The requirements are determined by the local financial regulator. In the United States, the SEC sets the requirements, which are outlined in Rule 501 of Regulation D.
The requirements in the United States are as follows:
1. Annual Income
A person must have an annual income that exceeds $200,000 ($300,000 for joint incomes) for the last two years. The individual must also expect the same or higher revenue in the current financial year.
2. Net Worth
A person must have a net worth of $1 million or higher, either as an individual or jointly (if married), at the time of purchase. The net worth calculation excludes the value of the individual’s primary residence. A general partner, director, or executive officer for the issuer of the unregistered securities may also be an accredited investor.
3. Entity Net Worth
An entity may be accredited if it is an organization with assets valued at $5 million or higher. The entity may also be considered an accredited investor if its owners are accredited investors.
However, an entity is not allowed accredited status if it was formed for the sole purpose of purchasing unregistered securities. The definition of an accredited investor was modified by the US Congress in 2016 to include investment advisors and brokers.
How to Become Accredited
There is no formal process that an individual or institution must follow in order to become an accredited investor. The task of verifying whether an individual or institution qualifies lies in the hands of the seller of unregistered securities.
The seller is required to verify the status of any individuals or institutions that are interested in buying the securities. In September 2013, the SEC made it mandatory for issuers of securities to take several steps to verify the status of individuals who want to buy the securities as accredited investors.
Generally, an investor is required to fill out a questionnaire, providing details such as annual income and net worth. They are also required to attach supporting documents such as financial statements for the last two years, account information, and tax returns.
Some issuers of securities may require additional information. This may include things such as a credit report or letters of review from financial advisors or attorneys.
Regulation of Accredited Investors
One of the reasons why financial regulators set requirements for accredited investors is to protect investors who may not be familiar with the investments they are investing in and, therefore, subject themselves to high risks of losing their money.
By setting such strict requirements, the regulator ensures that investors who earn the coveted accredited investor title are those who are knowledgeable about high-risk investments and financially stable enough to absorb any potential losses resulting from unregulated securities. In simple terms, the rules are aimed at protecting the investors rather than the issuers of unregulated securities.
Instead of limiting the trading of risky securities, regulators set limitations to allow only the most qualified and financially stable investors to invest in unregistered securities. Such investors can make huge returns if the investments are successful, or withstand the losses if the securities fail to yield the expected returns.
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