Private securities investor threshold needs a rethink, warns advisor

The number of investors who qualify to purchase private securities has expanded substantially thanks to inflation and retirement savings, increasing the potential for investor harm, the SEC said in a report Friday.

Only investors who meet certain financial thresholds, hold certain licenses or credentials or fit in other limited categories can participate in private placement offerings. Those securities are exempt from registration with the Securities and Exchange Commission under a measure called Regulation D.

A cornerstone of Reg D is the accredited investor standard. Established in 1982 and amended a couple times since then, individual accredited investors must have $1 million in investible assets other than the value of their homes or make $200,000 or more annually. Investors who don’t meet that criteria can qualify if they hold certain credentials, such as securities licenses, or have specialized knowledge about the private placement.

The parameters for accredited investors are meant to identify investors who have the wherewithal to withstand losses that could occur with private placements, which lack the disclosure requirements and other protections of public stocks.

But the standard was not indexed for inflation, which means it now encompasses many more investors than when it was implemented more than 40 years ago, according to the SEC's report. In addition, retirement savings that used to be ensconced in defined-benefit plans are now housed in individual retirement accounts, which count toward the net-worth prong of sophistication.

“Taken together, the increase in the size of the accredited investor pool over time as a result of inflation and the expanded role of retirement savings in qualifying as an accredited investor, have led some to question the continuing utility of the financial thresholds as a measure of accredited investors’ ability to sustain the risk of loss of investment with respect to accredited investors who are investing for imminent retirement or to provide income in retirement,” the SEC report states.

The SEC said 24.3 million households, or 18.5% of all U.S. households, qualify as accredited investors. That’s up from 1.5 million households, or 1.8%, in 1983. By 2032, the SEC estimates that approximately 30% of U.S. households will fall within the accredited investor definition.

If the standard had been indexed to one gauge of inflation, the net worth threshold would have risen to $3 million by 2022 and the income floor would have gone up to $607,000, the SEC said.

Another factor boosting the number of accredited investors is retirement savings. In the early 1980s, only 2.5% of retirement assets were in individual retirement accounts, compared to 34% in 2022, the SEC said. Overall, $11.5 trillion of the $33.6 trillion in retirement savings are in IRAs.

“This movement away from defined benefit plans may have created investor protection considerations not present to the same degree at the time of the adoption of the income and net worth thresholds,” the SEC report states. “Specifically, much of the responsibility for the management of retirement investments shifted from employers and professional pension fund managers to individual participants. Those individuals may have little, if any, prior investing experience and may not seek the assistance of professional advisors.”

The Dodd-Frank financial reform law mandated that the SEC issue a report every four years on the accredited investor standard. Many lawmakers and market participants have been pushing to expand the pool of sophisticated investors to help startup companies raise capital. State regulators and investor protection advocates have cautioned that private placements are a leading cause of investor harm.

“There needs to be a different way of reviewing who is qualified for these investments,” said Logan Bennett, senior financial advisor at Brexton Family Financial. “It’s something that [must] be discussed.”

A pending proposal regarding Reg D is on the SEC agenda. Indexing the accredited investor standard to inflation, adding qualifying credentials, establishing an SEC test for investor sophistication and deeming investors who work with investment advisors as accredited are among the reform ideas that have emerged in legislation and in the deliberations of SEC advisory committees.

The proliferation of online platforms offering private placements has made it easier for investors to access them. But those investors may not understand the often complex underlying fees and payback structures of the investments, Bennett said.

“It’s very much buyer beware,” Bennett said. “Let’s not lose sight of the risk of the private placements.”

From 2009 to 2022, approximately 9.6 million investors participated in Regulation D offerings, according to the SEC. The agency estimates that approximately $3.7 trillion of new capital was raised through private placements in 2022, compared to $1 trillion in public securities markets.