Are You An Accredited Investor?

Brenton: [00:00:00] To be an accredited investor is to have access to a pool of investments not available to the general public. And so you're surprise, you may already be one. In this episode, we talk about why. Let's get started. Brenton: Hello, my name is Brenton Harrison of New Money, New Problems, and your host for the New Money, New Problems podcast. This is one of our What's in the News episodes where we talk [00:01:00] about, a relevant financial news story that I think you should know about, and along those lines we're gonna be covering in this episode specifically, the topic of accredited investors. So what is an accredited investor? If you're following along with us on screen or reading from an Investipedia article, and it says that an accredited investor is an individual or business entity that's allowed to trade securities that may not be registered with financial authorities, they're entitled to this privileged access by satisfying at least one requirement regarding their income, net worth, asset size, governance status, or professional experience. So what does this all mean? Essentially, an accredited investor is an individual or an entity that's met a certain bar that the s e c, the Securities and Exchange Commission believes entitles them to call themselves a more complex investor, a more well-versed investor, and as a result, they are able to take advantage of certain things that are in the marketplace that they cannot offer to the general public. Why can't they offer [00:02:00] them to the general public? Because they believe that the general public does not have the tools necessary to evaluate whether that investment is appropriate or inappropriate for their portfolio. And this is a big thing because the premise of accredited investors primarily has to do with the issue of registered securities or unregistered securities. A registered security is something that has to go through the hoops of becoming a registered security with the Securities and Exchange Commission. It could be things like the stock that is a part of your mutual fund or your index fund , the things that you have in your 401k. All of those entities, had to go through the process of initially registering and being approved as a security with the S E C, but also the ongoing process of record keeping and making sure that they're not offering anything to the public that would harm them. Unregistered securities, however, are also called private placements. and a private placement is something that might be offered by an early stage business who's looking for capital or a hedge [00:03:00] fund, who's looking for investors. And if you're an unregistered security, you don't have to go through those same hoops. You don't have to make sure that you're checking all the boxes to make sure you're not harming the general public. Instead, you can offer your investment to accredited investors, and the thought is that because they're accredited, they have enough wherewithal to evaluate that investment so that you don't have to quote unquote, hold their hands throughout the process. And now that you understand what it means, we can talk about why it's such a hot topic amongst both Democrats and Republicans. Because there were two bills that were released and passed in the House of Representatives recently that were bipartisan bills. And it's very rare these days to have a bill that's agreed upon by both Democrats and Republicans. But the point of the bills is to address the fact that on both sides of the aisle, there is frustration about the metrics that are used to name someone an accredited investor. There are people out there who think that the definition is too stringent and in being too stringent, it shuts off [00:04:00] opportunities like minority communities, like any disadvantaged community from participating in an investment that might alter their financial life forever. And conversely, there are people on the other side of the coin who think that it should be more stringent because some of these investments are highly risky. And in allowing people who should not be accredited investors to participate in their mind, it's exposing the public to a potential danger from which they should be shielded. So no matter on which side of the aisle you stand, the one thing both sides agree upon is that the definition of accredited investor needs to be updated. So what does it mean to be an accredited investor? Going back to our article, an accredited investor is a person who must have an annual income exceeding $200,000 or $300,000 for a joint income for the last two years with the expectation of earning the same or a higher income in the current year. So the first check mark, and you only have to check one, is you have to be a high income earner. [00:05:00] Now the second check mark is you can also be considered an accredited investor if you have a net worth exceeding 1 million, but the calculation of that net worth cannot include the equity in your primary residence. Additionally, let's say that you are that private company who's looking for early stage capital. You can also be considered an accredited investor if you're a general partner, an executive officer, or the director of the company that's issuing the unregistered security, also known as the private placement. Now in terms of this podcast, I can look at the data and I can see that there's a wide range of incomes that listen to these episodes every week, for which I'm grateful. But I will also say there's a significant portion of people who might be listening to these episodes who heard that income check mark, and are saying, oh my goodness, I am an accredited investor. Who would've thought? Now there's probably a much smaller amount who has a net worth of a million dollars or more, excluding the equity in their home. We've talked about the fact that one of the ills that plagues first generation high [00:06:00] income earners is they often have so much Debt in acquiring the ability to Earn that income that they Earn, that it's very hard to make that net worth move higher, and in many cases you have a negative net worth. But there are plenty of people who listen to this podcast, who meet that $200,000 or $300,000 check mark, and this means that you could conceivably participate in some of these private placements. Whether you should, however, is a completely different story. And after the break, we'll tell you some of the updates as it relates to the accredited investor definition and cover, whether this is something that you should even be pursuing in your financial life. [00:07:00] Brenton: We're reading from an article from Smart Asset entitled, want to Invest in Private Securities? You may need to pass an exam under this bill, and it talks about the two bills that passed, the first being the Accredited Investor Definition Review Act. And this act [00:08:00] gives the Securities and Exchange Commission the discretion to establish the necessary certifications, designations, or credentials investors need to be accredited. And will require the commission to review those definitions every five years. What this means is that a big push in this drive to amend the definition of accredited investor is to acknowledge the fact that there are people who may not meet the financial requirements in order to be considered accredited, but they have met the education or literacy requirements. People like myself who have securities designations or certifications related to financial literacy, they're essentially saying that regardless of these people's finances, if they have passed those tests or received those designations, they should be included. So this first act asked the s e C to come up with a list of those designations that would pass the sniff test, and they would address and review those definitions and certifications every five years. Now the second act is the Fair Investment Opportunities for Professional [00:09:00] Experts Act, and this grants accredited investor status to individuals with certain licenses or educational professional backgrounds. And the sponsor of the bill says that my legislation is about leveling the playing field. Investors should be able to support small business startups in their local community across southwest Michigan and around the nation. And as an extension of this legislation, there was also a program called The Equal Opportunity for All Investors Act of 2023. This was sponsored by Mike Flood, a Nebraska Republican, so this bill that was passed would give the Securities and Exchange Commission one year following its enactment to set up an actual test that you can pass and be considered an accredited investor. It would give them one year to set up an exam program that, and I quote, is designed with an appropriate level of difficulty, such that an individual with financial sophistication would be unlikely to fail and includes methods that would demonstrate competency around different types of securities, private and public company disclosure requirements, corporate [00:10:00] governance, financial statements, potential conflicts and aspects of unregistered securities that include risks associated with limited liquidity and disclosures among other potential pitfalls. So all these things are working together to say there are some people who have been excluded, who should not have been excluded. They have met the bar of literacy that says they should be accredited. It also aims to kick some people out of the camp who have not displayed that literacy by pairing it with things like this exam. And the reason that literacy piece is so important is one of the things I think that's most common about your typical private placement investment is it's not very liquid. If you are that company who is seeking to get some capital from outside investors, they may be participating in a funding round, and all of these metrics might have to be hit for you to be able to withdraw your funds and you could have the potential of losing your investment completely. If you're investing in a hedge fund, that hedge fund is legally allowed to have a minimum amount of time that you have to be in that fund [00:11:00] before you can withdraw that money. And they may be able to restrict you from pulling your money out even after that time has passed. If you think that's a crazy concept, you should watch movies like The Big Short or Read the book, because this happened in 2008 when it came to the housing crisis, where they were hedge fund managers who were preventing their investors from withdrawing their funds as they try to right size the ship. And the reason I think this is so relevant to our listeners is because even though I would love for first time investors or disadvantaged communities to have access to some of these private placement investments, in my opinion, we often don't have some of the foundational elements in place that would say we're prepared to participate. But unfortunately, Many of my clients and many people I come across are actually offered the opportunity to do so because as we've discussed, when you are a high income earner in communities like the black community or any community where you might be the first or one of the few to Earn that type of income, there is the [00:12:00] assumption that you have everything together financially and that you have all this money laying aside that you can afford to invest and afford to lose. So when someone is trying to start a restaurant, when someone's trying to start a tech company, when someone's trying to get 25 or 50 or a hundred thousand dollars to form a commercial real estate development, they come to you and they ask you to pitch in because they assume that you have it. And I would say the overwhelming majority of the time, it's not that the opportunity may not be a great opportunity, it's that when I look at the finances of the person who's thinking about participating, There are some questions that I ask that they can't answer in the affirmative questions like, have you insured all the insurables? Do you have appropriate life insurance? If you die, do you have disability insurance? If you are injured and unable to work, do you have the appropriate homeowner's insurance to cover the risks associated with your property or auto insurance? Are all of those things in place? If you can't answer that question, how are you going to invest in a private placement when you haven't even covered the inherent [00:13:00] financial risks that already exist in your current finances? I'll ask them questions like, have you met your reserve goal? Do you have the three months or six months or years? Expenses in savings? Cash savings that you said you wanted when we started this process? If you don't, then we can't participate in an investment that may lock up your money for a certain period of time, or may make you lose all of the money that you invested. Are you already taking advantage of the registered securities at your disposal? Are you contributing to your 401k, up to your company match? Have you established a non-qualified investment account so that you're investing in things like index funds and exchange traded funds, and even single stocks that have a higher barrier to entry in terms of when they're presented to you as an investor? If you don't have any non-qualified investments that you can access before age 59 and a half, why are we automatically going to one that is typically going to be more risky than what you're bypassing in a non-qualified brokerage account? And there [00:14:00] are more. Is your credit in good enough shape? Do you have the financial literacy to explain this offer before you brought it to me? And do you have any liquidity needs for upcoming purchases or concerns that may dictate you needing to pull money out of this investment? If you don't have all these questions buttoned up, as enticing as it may be to participate in some of these early stage investments that you see or take advantage of these opportunities from people who happened to just put a few thousand dollars into this company before they became the next big thing. As tempting as that is, the answer would be no. So I happen to welcome some of these changes. I'm actually really intrigued by the prospect of this exam. I wonder what questions might be on there, but I think that anything that seeks to understand the fact that literacy has to be paired with high income and high net worth, in the end, while there will likely be some tweaks, is something that could prevent you from harm, and reinforces the concept that once you establish those foundational elements of your [00:15:00] finances, like we've talked about in previous episodes, it will only better prepare you to eventually be that investor who can freely participate in putting money towards that next big thing. I hope you enjoyed this episode. In the next few weeks, we'll be going into some more detail about investments that are available to you that might be appropriate, and I'm looking forward to joining you then I'll see you soon.