Accredited Investor Qualification: Do You Qualify Under SEC Rules?

An "accredited investor" is a person or entity that meets one of the definitions in SEC Rule 501(a) of Regulation D. Many private fund offerings are limited to accredited investors. The idea is that these participants are presumed able to evaluate, and bear the risk of, an unregistered offering.

For individuals, the main categories are income and net worth. The income test is individual income over $200,000, or joint income with a spouse or spousal equivalent over $300,000, in each of the two most recent years, with a reasonable expectation of the same level in the current year. The net worth test is individual or joint net worth over $1 million, not counting the value of your primary residence.

The August 2020 amendments added ways to qualify based on credentials and roles. Holders of Series 7, Series 65 or Series 82 licenses in good standing may qualify. So may "knowledgeable employees" of a private fund, for investments in that fund. Spousal equivalents may pool finances with each other. Entities such as corporations, partnerships and LLCs not formed just to invest can qualify with over $5 million in assets. Family offices with over $5 million in assets under management, registered investment advisers and exempt reporting advisers can qualify as well. An entity may also qualify if all of its equity owners are accredited.

Traditionally, issuers of private funds have relied on exemptions from SEC registration. Two common ones are Rule 506(b) and Rule 506(c). Under Rule 506(b), the issuer may not use general solicitation. Investors are usually accredited, and a limited number of non-accredited but sophisticated investors may take part, subject to disclosure requirements.

Rule 506(c) allows general solicitation, such as public advertising. In exchange, all purchasers must be accredited, and the issuer must take reasonable steps to verify that status. Under 506(b), issuers have often relied on self-certification, though practices vary by issuer.

Verification under 506(c) has often involved reviewing documents such as tax forms, bank or brokerage statements and credit reports. It can also involve a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney or certified public accountant. For entities and trusts, the review usually looks at the entity's assets or at who owns or controls it. The exact approach is up to the issuer and its advisers.

The right fund manager may help you understand which category you could fit into and what each offering expects from you. A first conversation is generally about your situation, your goals and how a private fund's structure works. You may be asked about the basis on which you believe you qualify, but a good conversation stays educational and never pressures you.

Questions worth asking include: Is this offering under Rule 506(b) or 506(c)? What verification steps do you require, and which documents or third-party letters do you accept? How do you handle qualification for trusts, LLCs, retirement accounts or family entities? How is my personal information stored and protected?

It may also help to ask how the manager explains risks, liquidity limits, fees and tax reporting such as Schedule K-1s. Also ask how Section 1202 (QSBS) might or might not apply to a given structure. Tax treatment depends on individual circumstances, so speak with your own licensed tax and legal advisers before deciding anything.