Regulators. 1). Second, the Dodd-Frank Act also requires SEC to review the  “accredited investor” definition in its entirety beginning in 2014 and  every 4 years thereafter and to conduct rulemaking as SEC deems  appropriate after each review. Net Worth Identified as Most Important Criterion for Qualifying as Accredited Investor

Among existing criteria, market participants whom we interviewed said a  net worth criterion was most important for balancing the goals of  protecting investors and facilitating capital formation. Two  market participants told us that net worth demonstrated an investor’s  ability to accumulate wealth over time. Specifically, we found  that increasing the minimum net worth or income thresholds would  decrease the number of eligible household investors. Our analysis of  federal household net worth data showed that adjusting the minimum  thresholds to account for inflation from $1 million to approximately $2.3  million—the inflation adjusted amount—would decrease the number of  households qualifying as accredited from approximately 8.5 million to  approximately 3.7 million. For example,  according to four representatives from associations, the small business  and investor communities would be resistant to increased thresholds  because this would limit the pool of investors. Market Participants Identified Alternative Criteria SEC Could Use in the Investor Standard

In addition to asking about the existing criteria, we asked market  participants about eight alternative criteria related to investors’ financial  resources and their understanding of financial risk. Among the financial  resources criteria, market participants thought a liquid investments  requirement (that is, a minimum dollar amount of investments in assets  that can be easily sold, are marketable, and the value of which can be  verified by a financial institution) was the most important for balancing  investor protection and capital formation. Figure 7  summarizes participants’ views on these alternatives. Of the six alternative  criteria related to an investor’s understanding of financial risk,  participants most often said that the registered investment adviser  criterion should be added to the existing criteria. However,  beyond excluding an investor’s primary residence in the calculation of net  worth in 2010, the standards for qualifying as an individual accredited  investor have remained unchanged since the 1980s. Recommendation for Executive Action

To further advance the goals of balancing investor protection and capital  formation in its accredited investor standard, SEC should consider  alternative criteria, including those in this report, to help determine an  individual’s ability to bear and understand the risks associated with  investing in private placements. For example, market participants that we  spoke with identified adding a liquid investment requirement or use of an  investment adviser as alternative criteria that would balance investor  protection and capital formation, be relatively feasible to implement, and  have some level of acceptance by the market. SEC said that it would consider alternative criteria  (particularly, adding liquid investments and the use of a registered  adviser) when it completes its mandated review. For both objectives, we reviewed the Securities and Exchange  Commission’s (SEC) current definition and legislative history of the  standard. To examine market participants’ views on the existing criteria for  accredited investor status, and the potential effects of changes to the  standard on investor protection and capital formation, we conducted  structured interviews by telephone with a judgmental sample of 27 market  participants whom we categorized in four groups intended to represent  different segments of the accredited investor population: (1) attorneys  who have experience in private placement transactions, (2) accredited  investors who invest in private placement securities, (3) retail investors  who meet the current accredited investor criteria but do not actively invest  in private placement securities, and (4) investment advisers and broker- dealers who work with accredited investors. From the  list of proposed and foreign regulator criteria, we identified a list of criteria  that was consistent with the intended purpose of the accredited investor  standard and that could be used to qualify individual investors as  accredited.
Why GAO Did This Study

Accredited investors who meet certain income and net worth thresholds may participate in unregistered securities offerings. GAO determined that the intended purposes of the accredited investor standard are to (1) protect investors by allowing only those who can withstand financial losses access to unregistered securities offerings and (2) streamline capital formation for small businesses. To qualify as accredited, SEC requires an investor to have an annual income over $200,000 ($300,000 for a married couple) or a net worth over $1 million, excluding a primary residence. The thresholds were set in the 1980s and 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act mandates GAO to study the criteria for qualifying individual investors as accredited.
This report examines market participants' views on (1) the existing criteria for accredited investor status and (2) alternative criteria. To address these objectives, GAO conducted a literature review, examined relevant data, and interviewed domestic and foreign regulators and industry representatives to identify alternative criteria. GAO also conducted structured interviews of 27 market participants (including broker-dealers, investment advisers, attorneys, and accredited investors).

What GAO Found

Of the existing criteria in the Securities and Exchange Commission's (SEC) accredited investor standard, many market participants identified net worth as the most important criterion for balancing investor protection and capital formation. For example, two market participants said the net worth criterion, more so than income, likely indicates the investors' ability to accumulate wealth and their investment knowledge. Others noted that some parts of the market might not accept adjustments to the thresholds. For example, an association of angel investors--accredited investors who invest in start-up companies--told GAO that they would be resistant to increased thresholds because it would decrease the number of eligible investors. GAO analysis of federal data on household net worth showed that adjusting the $1 million minimum threshold to approximately $2.3 million, to account for inflation, would decrease the number of households qualifying as accredited from approximately 8.5 million to 3.7 million.
While citing net worth as the most important criterion, several market participants GAO interviewed said that alternative criteria related to an investor's liquid investments and their use of an investment adviser also could balance investor protection and capital formation. GAO obtained views on eight alternative criteria that focus on investors' financial resources and their understanding of financial risk--criteria that SEC or industry groups previously proposed or that foreign regulators use. Among the financial resources criteria, market participants with whom GAO spoke most often identified a liquid investments requirement--a minimum dollar amount of investments in assets that can be easily sold, are marketable, and the value of which can be verified--as the most important for balancing investor protection and capital formation. Among the understanding financial risk criteria, market participants most often identified the use of a registered investment adviser. Beginning in 2014, SEC must review the accredited investor definition every 4 years to determine whether it should be adjusted. This study provides a reasonable starting point for SEC's review. Specifically, SEC will have the views of market participants about how existing and alternative qualifying criteria could help determine an investor's ability to bear and understand risks associated with unregistered securities offerings.

What GAO Recommends

SEC should consider alternative criteria for the accredited investor standard. For example, participants with whom GAO spoke identified adding liquid investments and use of a registered adviser as alternative criteria. SEC agreed with GAO's recommendation.