An accredited investor is an individual or entity that meets certain SEC thresholds that permit them to invest in less regulated investment opportunities, like hedge funds or oil wells.
A person is considered to be an accredited investor by meeting the following SEC criteria:
- Maintaining a net worth of $1 million+ , individually or jointly with a spouse, not including the value of your primary residence;
- Earning individual income above $200,000 (or $300,000 in joint income with a spouse) in each of the past two years, with a reasonable expectation of meeting the same income threshold for the current year; or
- Meeting any one of these additional criteria:
- The investor is a “knowledgeable employee” of a private securities fund, as determined by that particular fund;
- The investor is an executive officer, director, trustee, general partner, advisory board member or person serving in a similar capacity of the issuer or an affiliated management person; or
- The investor is a SEC- and/or state-registered investment adviser, general securities representative or private securities offering representative. The current requisite designations include individuals that maintain Series 7, Series 65 or Series 82 licenses in good standing with their relevant member firm.
Meeting these guidelines shows the SEC that you have the necessary financial know-how, resources and risk tolerance for investing in less regulated investment opportunities. An estimate in 2020 found nearly 13,665,475 or 10.6% of all US households qualify for this investor status.
An individual who doesn’t meet this criteria doesn’t attain this accredited investor status and is known as a non accredited investor.
What Is the Accredited Investor Verification Process?
The SEC does not certify you as an accredited investor, nor can you apply to them to get a certification.
To gain accredited status, you only need to satisfy SEC’s criteria about income, net worth, knowledge level or affiliations.
However, per SEC regulation under Rule 506(c), the onus of proving your accredited investor status falls on the issuer of the securities offering. They cannot simply rely on the investor’s word. Instead, the issuer must take “reasonable steps” to verify this status (not to be confused with the “reasonable belief” standard from Rule 506(b)).
Issuers can verify an investor’s status through any of the following three methods:
Insider Method
If someone is a director, executive officer, or general partner of the securities issuer, they’re considered an accredited investor.
The issuer should have this information readily available, but they can also point to publicly available or internal information such as securities filings, research reports, governing documents, resolutions, or other certificates to confirm.
[Certain funds choose to only verify the status of an accredited investor once (or once per calendar year).
Income Method
Demonstrating that one has an income that exceeds $200,000 (alone or $300,000 with a spouse) and reasonably expects a similar level of income in the future will is sufficient to grant a potential investor an accredited status.
Some documents that can prove an investor’s accredited status include:
- Tax filings or pay stubs;
- A letter from an accountant or employer confirming their actual and expected annual income; or
- IRS Forms like W-2s, 1040s, 1099s, K-1s or other tax documentation that report income.
Net Worth Method
Confirming that an individual’s (or a spousal couple’s) joint net worth is in excess of $1M (not including the value of one’s primary residence) is also sufficient for earning accredited status.
However, the potential investor must provide documentation revealing all of their asset and liability information to accurately calculate net worth.
This may include their:
- Credit report
- IRS forms
- Consumer credit report listing all liabilities outstanding
- Deeds or other evidence of ownership for real estate holdings
- Third-party valuation of property holdings
- Value of private company securities holdings
- Proof of vehicle ownership
For investors with no liabilities and a single large bank account, this method could be very easy. But for people with multiple assets or liabilities, this could be very complicated and time-consuming.
The Problem with The Traditional Investor Verification Method
Accredited investor verification is a relatively new process for issuers and investors alike. This leads to a lot of confusion about the exact process requirements on both sides.
More importantly, since the investor needs to prove their accredited status with each new opportunity, it results in a ton of duplication and wastage of time and money.
Additionally, from the issuer’s perspective, having to go through each new investor’s credentials manually can be just as time-consuming and inconvenient.
However, Rule 506(c) offers a solution to these problems by way of the third-party verification method.
As an alternative to the issuer manually reviewing each investor’s documents, they can instead obtain a letter from a third-party attesting as to the investor’s accreditation status. This letter allows the issuer to fall into a “safe harbor” so long as the grantor of the letter is one of the following:
- a registered broker dealer;
- a registered investment advisor;
- an attorney; or
- a certified public accountant.
There is no specific verification requirement for what the letter should look like, but these third-party verification letters typically indicate which test the investor meets, how the signatory on the letter qualifies as an evaluator and the date on which the evaluator made their review.
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