Report on the Review of the Definition of “Accredited Investor” This is a report by the staff of the U.S. Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings or recommendations contained herein. _____________________________ December 18, 2015 Table of Contents I. Introduction ....................................................................................................................................... 1 A. Background ................................................................................................................................. 1 B. Accredited Investor Definition .................................................................................................. 2 C. Reasons for the Report ............................................................................................................... 4 D. Goals of the Accredited Investor Definition ............................................................................. 5 E. Scope of the Report ..................................................................................................................... 6 F. Recommendations ....................................................................................................................... 7 II. History of the Accredited Investor Definition ................................................................................ 8 A. Securities Act Section 4(a)(2) and Judicial Precedent ........................................................... 10 B. Small Business Exemptions Prior to Regulation D ................................................................ 12 C. The Small Business Investment Incentive Act of 1980 .......................................................... 14 D. Regulation D .............................................................................................................................. 15 III. Other Regulatory Approaches ....................................................................................................... 21 A. Qualified Client ......................................................................................................................... 23 B. Qualified Purchaser Under the Investment Company Act ................................................... 25 C. Qualified Purchaser Under the Securities Act ....................................................................... 27 D. Qualified Institutional Buyer ................................................................................................... 29 E. Qualified Investor ..................................................................................................................... 30 F. Eligible Contract Participant ................................................................................................... 31 G. Uniform Securities Act of 2002 ................................................................................................ 32 H. Franchise Laws ......................................................................................................................... 32 I. International Approaches ........................................................................................................ 34 IV. Accredited Investor Attributes ...................................................................................................... 40 A. Current Definition .................................................................................................................... 41 B. Criticisms of the Current Definition ....................................................................................... 43 C. Potential Adjustments to Income and Net Worth.................................................................. 46 D. Potential New Criteria .............................................................................................................. 57 V. Should the Accredited Investor Definition Be More Flexible? ................................................... 67 A. Opportunities for Scaling ......................................................................................................... 68 B. Advantages and Disadvantages of Scaling ............................................................................. 71 VI. Spouses and Spousal Equivalents .................................................................................................. 72 VII. Accredited Investor Entities ........................................................................................................... 76 A. Current Framework ................................................................................................................. 76 B. Certain Entities Not Included in the Current Definition ...................................................... 79 C. Alternative Frameworks .......................................................................................................... 83 VIII. Implications Outside of the Regulation D Context....................................................................... 85 IX. Recommendations ........................................................................................................................... 88 X. Impact of the Potential Approaches on the Pool of Accredited Investors .................................. 97 A. Impact of Potential Approaches .............................................................................................. 99 B. Non-Quantifiable Approaches ............................................................................................... 103 C. Combined Impact of Quantifiable Approaches ................................................................... 104 D. Number of Accredited Investors that May Invest in Regulation D Offerings .................. 107 E. Profile of Accredited Investor Pools Qualifying Under Current Standards and Recommended Standards ...................................................................................................... 109 F. Geographic Distribution of Accredited Investor Households ............................................. 112 G. Future Indexing for Inflation ................................................................................................ 114 i REPORT ON THE REVIEW OF THE DEFINITION OF “ACCREDITED INVESTOR” I. Introduction A. Background Absent an available exemption, the Securities Act of 1933 (the “Securities Act”) requires that offers and sales of securities be registered with the Securities and Exchange Commission (the “Commission”). Registration is intended to provide investors with full and fair disclosure of material information so that they are able to make their own investment decisions.1 Congress, however, recognized that in certain situations there is no practical need for registration or the public benefits from registration are too remote.2 Accordingly, the Securities Act contains a number of exemptions to its registration requirements and authorizes the Commission to adopt additional exemptions. The exemptions in Regulation D3 are the most widely used transactional exemptions for securities offerings by issuers. Issuers using these exemptions raised over $1.3 trillion in 2014 alone, an amount comparable to what was raised in registered offerings.4 1 See, e.g., Commissioner Francis M. Wheat, Disclosure to Investors - A Reappraisal of Federal Administrative Policies under the ’33 and ’34 Acts (Mar. 1969) (often referred to as the “Wheat Report”). 2 H.R. Rep. No. 73-85 (1933). 3 Regulation D – Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933, 17 CFR 230.500 through 230.508. 4 See Scott Bauguess, Rachita Gullapalli and Vladimir Ivanov, Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009-2014 (Oct. 2015) (the “Unregistered Offerings White Paper”), available at http://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10- 2015.pdf. Underlying data in the Unregistered Offerings White Paper was obtained from Form D filings. While Rule 503 of Regulation D (17 CFR 230.503) requires the filing of a notice on Form D no later than 15 days after the first sale of securities, the filing of a Form D is not a condition to a Regulation D safe harbor or exemption. Consequently, it is possible that some issuers do not make Form D filings for offerings relying on Regulation D and the available data on Regulation D offerings could underestimate the actual amount of capital raised through those offerings. 1 B. Accredited Investor Definition The “accredited investor” definition is a central component of Regulation D. It is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”5 Qualifying as an accredited investor is significant because accredited investors may, under Commission rules, participate in investment opportunities that are generally not available to non-accredited investors, such as investments in private companies and offerings by hedge funds, private equity funds and venture capital funds. Issuers of unregistered structured finance products and debt securities also may rely on Regulation D. Investors in unregistered offerings can be subject to investment risks not associated with registered offerings because some securities law liability provisions