SEC Amendments to Accredited Investor Definition

The Security & Exchange Commission in the United States of America has amended the definition of the accredited investor, impacting cryptocurrency, and security token markets globally.

Today marks an important milestone for the financial industry, and in particular, the blockchain and security token markets, where a broader range of investors will have access to invest in private companies through blockchain technology. The SEC, known as the world’s strictest financial regulator, has acknowledged the need to offer private investments to individuals with specific knowledge and experience. With this acknowledgment comes a new definition of the accredited investor; a definition we believe will become even broader and include more investors over the course of the next few years. For private investments and regulated token offerings, this represents major growth in global investment opportunities.

Background

Investments are often sold through a prospectus, which contains detailed information about the company or fund issuing the securities and the risks involved in purchasing them. One of the main purposes of a prospectus is to protect the investor, and the issuance of a prospectus is seen as a barrier for young companies to raise funds.

Financial regulators have recognized the need to balance investor protection with economic growth; allowing young, private companies to raise funds with appropriate restrictions. They established the accredited investor definition — individuals who can invest in private companies raising funds without issuing a prospectus.

Accredited investors include institutions such as banks, insurance companies, pension funds, governments, Crown corporations, and some individuals. Each country has their own threshold for what qualifies a person as an accredited investor.

For example, in the United States, an accredited investor was (until today) defined as someone with a net worth of at least $1 million or an income of $200 thousand in each of the last two years. These individuals have access to private financial markets that the broader public does not, creating an opportunity imbalance between the haves and the haves nots.

But why are financial metrics being used as a barometer to measure someone’s knowledge of potential investment opportunities? For technology investments, isn’t it likely that a young computer scientist has a better materially understanding of emerging technologies than an individual with a high net worth?

For these reasons, the SEC, who revisits their definition of the accredited investor every four years, amended their definition of who qualifies as an accredited investor, signaling that more changes are to come in the future.

Entering the era of investor accreditation through education…

The Amendment

The amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth. They also expand the list of entities that may qualify as accredited investors.

“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.” — Jay Clayton, Chairman SEC

The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.

With regards to Rule 501(a), the amendments are:

• To add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the Commission with the flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
• To include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
• To clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
• To add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51–1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
• To add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
• To add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

Breaking this down, there are 3 major takeaways:

1. The SEC is adding designations and credentials to their definition, specifically the Series 7, Series 65 and Series 85 licenses. This list is likely to expand in the future, and it’s surprising that charter holders (CFA and CPA) are not included at this time. At present, the Series 65 license is the only license on this list that does not require sponsorship from a FINRA member firm. The Series 65 license can be obtained by individuals who are not affiliated with any firm by submitting a U10 Form and paying the $175 exam fee (and receiving a passing score on the exam of course). The test examines knowledge of economics, business information, investment vehicles, investment strategy, and legal regulations and ethical business practices, but the largest takeaway here is that an individual doesn’t necessarily need to have a traditional financial education or the privilege of working at a financial institution to obtain the designation.
2. Knowledgeable employees of private funds are included, which seemingly means that junior analysts can now qualify
3. Smaller family offices, and LLCs, with at least $5M AUM can now qualify

The amendment to Rule 215 expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition.

The Implications

Traditionally fundraising, especially in the early stages, is mainly jurisdictional and geographically gated. Blockchain and the emergence of initial coin offerings (ICO) changed that and showed the world there is a better way and a way to reach a global investment audience in a secure and transparent way.

This fundraising innovation was met with heavy criticism and many regulators around the globe came down hard on blockchain companies that were raising funds through an ICO. The lack of education in the space created fear and stifled the growth of this industry and the great technology that underpins it.

Today, education is now paving the way to the future of funding. Accreditation by education levels the playing field and allows a knowledgeable person to make their own decision and risk tolerance to invest at the same level that was once only held for individuals of high net worth or had a close tie to the project itself.

For the small, retail investor, it means that it’s no longer David vs. Goliath when it comes to investing and the rich will no longer have an advantage in early stage investments like they did before. It is now David vs. David and everyone has the opportunity to be Goliath.

In the blockchain industry, most investors that invested in ICOs (and did not come through a fund) had to do so through smart contracts using blockchain technology itself. This means that each investor had the knowledge to onboard themselves to the blockchain universe, set up a wallet, and send a blockchain transaction. This is specialized knowledge, and with future advancements in the SEC’s definition of defines an accredited investor, should satisfy the education requirement.

Moving forward, lowering the education requirement to self-attained certifications will give young enthusiasts equal opportunity to profit off of an investment as a rich individual sitting with their broker.

The US Securities & Exchange Commission is seen globally as a leader in financial regulation, as it is the strictest jurisdiction. Public blockchain offerings in the past tend to go one of two ways:

1. Exclude US investors to conduct the raise in a jurisdiction with more favorable guidelines
2. Conduct the raise out of the US and use their regulation as a benchmark for the rest of the world; assuming that following their guidelines assures compliance globally

Extrapolating this viewpoint, following US regulations for a global token sale can ensure compliance in other jurisdictions; meaning that accreditation through education will soon be accepted globally.

Next Steps

Recognizing that the SEC left their current education requirements quite narrow (for now), SEC Commissioner Hester Peirce called the update a “cautious” expansion. She is advocating for an even wider definition to allow smaller investors access to growing private markets.

“These newly minted accredited investors are not your typical mom and pop retail investors, a fact that should assuage the concerns of those that fear any expansion of the definition,” said Peirce in her statement. “It does not assuage my concerns. Why shouldn’t mom and pop retail investors be allowed to invest in private offerings? Why should I, as a regulator, decide what other Americans do with their money?” — Hester Pierce, SEC Commissioner

Pierce said that these changes are just the “tip of the iceberg” in allowing accreditation through education, hinting that there will be more certifications and educational hurdles that the SEC will recognize in the future for accreditation.

While Pierce is vocally in favour of a lower barrier to entry, that’s not the case for all commissioners. In a joint statement, SEC Commissioners Allison Herren Lee and Caroline Crenshaw cited concerns with private offerings in general lacking transparency and liquidity.

“This ignores the naturally opaque nature of the private market where issuers are not required to provide the robust disclosures that are features of public offerings. No matter how powerful your computer is, you cannot access information that is not there.”

With Mogul, our mission is to create data-driven standards for film financing, production and distribution using blockchain technology. We’ve taken on this mission because we agree — private investments, and specifically independent film investments, lack information and financial transparency for investors. Our model and technology not only provides more information, but we also collect individual investor information and data that other private offerings don’t have.

The next review of the definition is set to occur in four years, but in this time, based on the comments and sentiment around today’s announcement, we expect a lower barrier for the educational requirement.

This set of amendments will take effect 60 days after publication in the Federal Register.