Once-exclusive 'accredited investor' tag on track to apply to half of U.S. households

With no inflation adjustments to the criteria for who counts as an "accredited investor" in four decades, the number of households fitting the definition has swollen sixteenfold.

And unless regulators start erecting further barriers to entry, the accredited investor crowd is expected to grow large enough in the next 20 years to encompass nearly half of all U.S. households. Accredited investors are generally meant to be members of an exclusive club deemed fit by their financial sophistication and wherewithal to put money into hedge funds, private investments in startup firms and other risky vehicles not commonly traded on public markets.

Since 1982, the Securities and Exchange Commission has defined these sorts of investors as people with a net worth of at least $1 million or more than $200,000 in annual income in each of the previous two years. The criteria have been refined several times since then. 

In 1988, for instance, the Wall Street regulator decided to admit households with a joint annual income of $300,000 over the past two years. In 2011, it said investors' primary residences had to be excluded from the net worth calculation.

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But the basic thresholds have remained the same even as inflation has eroded the buying power of the dollar. That has meant a steep increase in the number of U.S. households meeting the criteria for accredited investors.

Time for review?
A report SEC staff released on Dec. 15 suggests those standards could be due for revision. Jay Gould, a former SEC lawyer and current special counsel in the San Francisco office of Baker Botts, noted that the report makes no specific recommendations.

But its prediction that nearly half of all U.S. households will meet the definition of accredited investor in the next 20 years does raise real questions over whether the net worth and income criteria are serving their intended purpose. 

"They are laying the groundwork for saying, should we index this to inflation?" Gould said in an interview. "Or should we have additional standards?"

According to the SEC's report, in 1983 only 1.51 million households met the definition, or 1.8% of the total. By 2022, that number had risen to 24.3 million households, or 18.5% of the total. And if nothing changes, it will approach 80 million by 2042 —nearly half of all U.S. households.

If the SEC's thresholds had kept pace with inflation, the net worth limit would now stand at a little above $3 million. The income limits would be around $608,000 for individuals and $911,000 for households with joint incomes.

How much money are we talking?
Gould said the SEC has struggled to gauge how much money annually goes into the sorts of nonpublic investments that are typically reserved for accredited investors. The agency's report estimates that $3.7 trillion was raised by these means in 2022, much of it going to private startup firms. Registered offerings on regulated public markets brought in only $1 trillion in the same period.

But Gould noted that the SEC acknowledges in its own report that unregistered offerings, by their very nature, are difficult to track.

Once every four years
The SEC's report is a result of a provision in the Dodd-Frank Act of 2010 requiring the SEC to review its standards for accredited investors every four years. Gould said he thinks the SEC has the legal authority to change the standards on its own, although any attempt of that sort might lead to legal challenges.

Usha Rodrigues, a professor of corporate finance and securities law at the University of Georgia, said in an interview that there's sometimes a perception that the accredited investor laws exclude regular investors from opportunities that allow the rich to grow only richer.

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"When times are good, people are pressed up against the glass and wondering, why can't we do what everybody else is doing?" Rodrigues said. "The thought is that this is not fair and it's not American."

But when the bottom drops out of these riskier investments, a hue and cry often goes up asking why less sophisticated investors weren't better protected, she said.

Legislation situation
Even as some question if the definition of accredited investor could stand some tightening, Congress in recent years has put forward a variety of bills meant to lower the gates. The Fair Investment Opportunities for Professional Experts Act, passed by the U.S. House of Representatives in June, would expand the definition to include certified broker-dealers, investment advisors or others who have certain professional licenses or experiences. 

The legislation is similar to an internal SEC order from Aug. 20 extending the definition of accredited investor to federal- or state-registered advisors and certain holders of brokerage licenses, among others. Like similar pieces of legislation in recent years, its chances of adoption by both chambers are slim.

Gould said he thinks Democrats in the Senate will resist attempts to admit more households into the ranks of accredited investors. He also predicted any attempt by the SEC to tighten the admission standards will probably wait until after the presidential election in November.

"It's probably time that they do something," he said. "But I wouldn't expect anything immediately."

Carve-out for startups?
Rodrigues said one argument commonly made by advocates of looser criteria is that the current qualifications make it difficult for private startup firms to raise money from regular investors. Difficulties with accessing capital are one of the biggest struggles for companies that are just getting started.

Rodrigues said that if lawmakers are seeking to ease the way for startups, they could devise an exception that allows non-accredited households to put money into them while still keeping up the barriers to investing in hedge funds and other risky alternatives.

"I'm not anti-hedge funds," Rodrigues said. "But I really do think there is an argument that there needs to be a more direct path to capital markets with respect to startups rather than for hedge funds or derivative plays."