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Will the SEC Redefine Who Can Be an 'Accredited Investor'? If the government loosened up restrictions, more money could be freely distributed to entrepreneurs and small businesses.

By Kendall Almerico

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

For years, federal law has only allowed "accredited investors" to invest in most private-securities offerings for startup and growing businesses. This will change to a certain degree with the enactment of equity crowdfunding under the JOBS Act, but there will still be a large number of private investments limited to accredited investors.

This month, the Securities and Exchange Commission will consider revising the definition of who qualifies as an accredited investor. Unfortunately, some of the proposals the SEC is considering would make qualifying as an accredited investor more difficult, and thereby limiting the pool of investment money that presently is available to small businesses.

Related: Thriving in Finance Requires Patience and Humility

Currently, an investor is accredited if his or her net worth exceeds $1 million, excluding a primary residence, or if their income is $200,000 or more. Most estimates say there are more than 9 million people in the United States that qualify under this easy-to-verify standard. Of that number, it is estimated that a small percentage actually invest in startups and small businesses.

The theory behind the accredited investor rule is that someone who makes a lot of money, or has a high net worth, is sophisticated enough to determine if an investment is risky or not, and can withstand the loss if the investment goes bad. More than 60 years ago, the U.S. Supreme Court decided that someone who has a lot of money "can fend for themselves" when it comes to investments.

Of course, this reasoning is idiotic. Anyone who hears the horror stories about millionaire athletes or lottery winners who lose everything knows that a high net worth does not equal investing sophistication. But having a simple, income-based definition of accredited investor gives everyone involved in the process certainty that the investor is accredited, thereby avoiding legal troubles when an investment goes bad.

The reality is, there are millions of financially-sophisticated people who are not able to invest in private offerings because of this rule. Yet, if you are a securities lawyer, an investment banker, a stock broker, a certified public accountant or a tax advisor, but do not have a net worth of more than $1 million, or did not earn $200,000 last year, the SEC does not consider you sophisticated enough to be called an accredited investor.

Think about it. These people can give advice to others about investments, accounting and taxation, but they cannot participate in the investments themselves because they do not meet an arbitrary amount of earnings or wealth.

The Dodd-Frank financial reform law requires the SEC to review the accredited investor standard this year, the first time a review has been done since 1982. The SEC is meeting this week to consider major changes to the definition of accredited investor, a decision that will have far-reaching implications to entrepreneurs in the near future.

Related: Billionaires are Hoarding Piles of Cash

What will the SEC decide to do? Here are four possibilities:

1. They could increase the monetary requirements.

Some people believe that the 30-year-old $200,000 salary and $1 million net worth thresholds are too low, and should be raised. Small businesses will suffer if the already-small number of people who qualify to invest is restricted even more.

The SEC estimates that increasing these numbers to account for inflation since 1982 would exclude 60 percent of those considered accredited investors from being allowed to continue investing in private placements.

2. They could scrap the monetary requirements, and require proof of investment sophistication.

The SEC might allow people with certain professional licenses to automatically be labeled as accredited investors, and for others to provide other demonstrable proof. While this seems like a good idea, having a license to dispense investment advice, for example, does not mean that someone is able to handle the loss of a large investment in a private placement. And how will others be tested or qualified?

3. They could broaden the number of people who are accredited, but limit the amount they can invest.

In the equity crowdfunding provisions of the JOBS Act, there are limitations of how much someone can invest in certain offerings, and these seem reasonable on their face as a way to protect investors from catastrophic losses.

But is it truly fair for the government to tell someone who is a "sophisticated investor" that their investment is limited to some arbitrary percentage of their income? If so, why doesn't the government prevent anyone, even non-accredited investors, from "investing" as much as they want in slot machines at casinos? Does the government prevent grandma from using her retirement nest egg to buy as many lottery tickets as she wants?

4. They could do some combination of the above.

This is my best guess of what will happen. I suspect we will see new, slightly higher financial thresholds, a group of licenses or occupations that become accredited investors automatically and, unfortunately, some limitation on the amount certain accredited investors will be allowed to invest.

Related: Want to Get Rich? Know How to Diversify Your Investments.

Kendall Almerico

Crowdfunding Attorney and JOBS Act Expert

Kendall Almerico is a crowdfunding and JOBS Act attorney with law firm of Almerico Law in the Washington, D.C. area. He is CEO of BankRoll, a JOBS Act equity crowdfunding platform.

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