Non-Accredited Investor

For individuals, the primary financial thresholds for accredited investor status are a net worth exceeding one million dollars individually or jointly with a spouse or spousal equivalent, excluding the value of the primary residence as discussed in the Net Worth article, or annual income exceeding two hundred thousand dollars in each of the two most recent years with a reasonable expectation of the same income level in the current year, or three hundred thousand dollars jointly with a spouse or spousal equivalent applying the same two-year history and current year expectation. The Dodd-Frank Act and subsequent SEC amendments have also expanded the accredited investor definition to include individuals holding certain professional certifications, designations, or credentials demonstrating financial sophistication, most notably holders of the Series 7, Series 65, or Series 82 licences in good standing, and knowledgeable employees of certain private funds.

For entities, accredited investor status is available to banks, registered broker-dealers, insurance companies, registered investment companies, and business development companies regardless of their size, and to other entities including corporations, partnerships, limited liability companies, and trusts with total assets exceeding five million dollars if not formed for the specific purpose of acquiring the securities being offered, and to any entity in which all of the equity owners are accredited investors.

A non-accredited investor is simply any individual or entity that does not satisfy any of these accredited investor criteria. The vast majority of the US population falls into the non-accredited investor category, as the one million dollar net worth threshold and the two hundred thousand dollar income threshold exclude most households from accredited investor status. This broad exclusion reflects the regulatory judgment that the majority of individuals lack the financial resources and sophistication to evaluate and absorb the risks of unregistered private securities offerings without the protections of the full registration and disclosure framework of the Securities Act.

Regulatory Implications of Non-Accredited Investor Status

The inclusion of non-accredited investors in a private securities offering has significant regulatory consequences that affect both the structure of the offering and the disclosure obligations of the issuer.

Under Rule 506(b) of Regulation D, the most commonly used exemption for private placements, issuers may sell securities to an unlimited number of accredited investors and up to thirty-five non-accredited investors in any single offering, provided that each non-accredited investor either alone or with a purchaser representative has such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of the prospective investment. This sophistication requirement for non-accredited investors participating in Rule 506(b) offerings reflects the regulatory concern that non-accredited investors who lack financial sophistication in addition to failing to meet the wealth thresholds are particularly vulnerable to harm from inadequately understood private investment risks.

The inclusion of even a single non-accredited investor in a Rule 506(b) offering triggers additional disclosure requirements that do not apply to offerings made exclusively to accredited investors. Specifically, if non-accredited investors are included, the issuer must provide all investors with disclosure documents containing substantially the same information as would be required in a registered offering, including audited financial statements for specified periods. This disclosure requirement significantly increases the cost and complexity of private placements that include non-accredited investors, creating a strong practical incentive for issuers to limit their offerings to accredited investors only.

Rule 506(c) of Regulation D, added by the JOBS Act of 2012, allows issuers to engage in general solicitation and general advertising of their private offerings, which is prohibited under Rule 506(b), but only if all purchasers in the offering are accredited investors and the issuer takes reasonable steps to verify the accredited investor status of all purchasers. The ability to use general solicitation is conditioned on the exclusion of all non-accredited investors, reflecting the regulatory concern that general solicitation could expose non-accredited investors to speculative private offerings through mass marketing channels without the disclosure protections applicable to registered offerings.

Protecting Non-Accredited Investors

The regulatory framework's differentiated treatment of accredited and non-accredited investors reflects several important rationales for providing non-accredited investors with additional protections in the private securities markets.

The information asymmetry argument holds that non-accredited investors typically lack the access to management, legal counsel, accountants, and other information sources that sophisticated institutional and high-net-worth investors use to evaluate private investment opportunities. A venture capital firm considering an investment in a private company can negotiate for detailed financial information, management meetings, references from other investors, and full access to company records through a comprehensive due diligence process. A non-accredited individual investor is unlikely to have the relationships, expertise, or bargaining power to obtain comparable access to information, placing them at a fundamental informational disadvantage relative to the sophisticated investors they would be co-investing with.

The risk absorption argument holds that even if non-accredited investors could obtain adequate information about a private investment, their more limited financial resources mean that they have less capacity to absorb losses from unsuccessful investments. An accredited investor with a net worth of five million dollars who loses fifty thousand dollars on a failed private placement has suffered a one percent loss of their net worth, an uncomfortable but manageable setback. A non-accredited investor with a net worth of one hundred thousand dollars who loses fifty thousand dollars has suffered a fifty percent loss of their net worth, a potentially devastating financial blow that could permanently impair their financial security.

The liquidity argument notes that private securities are typically illiquid, with no ready secondary market in which investors can sell their holdings if they need to access their capital or if the investment deteriorates. Non-accredited investors who need their capital for living expenses, emergencies, or other financial obligations may find themselves unable to exit a private investment when they need liquidity, a circumstance that could force them to accept a distressed sale price or to maintain an illiquid position they can no longer afford to hold.

Regulation A and Crowdfunding: Pathways for Non-Accredited Investors

Recognising that the complete exclusion of non-accredited investors from private capital markets may be overly restrictive and may limit the ability of smaller companies to access a broader pool of retail capital, Congress and the SEC have created several pathways through which non-accredited investors can participate in certain types of private or semi-private securities offerings with appropriate investor protections.

Regulation A, as modernised by the JOBS Act of 2012 and the subsequent SEC rulemaking, provides an exemption from full Securities Act registration for public offerings of up to seventy-five million dollars per year in a Tier 2 offering or twenty million dollars per year in a Tier 1 offering. Regulation A offerings may be made to both accredited and non-accredited investors, allowing companies to access retail investor capital without the cost and complexity of a full IPO. Regulation A offerings are subject to significant disclosure requirements including offering circulars similar to prospectuses, ongoing reporting requirements for Tier 2 offerings, and investment limits for non-accredited investors in Tier 2 offerings that restrict individual investments to no more than ten percent of the investor's annual income or net worth.

Regulation Crowdfunding, established by the JOBS Act and implemented by the SEC under Regulation CF, allows companies to raise up to five million dollars per year from both accredited and non-accredited investors through registered crowdfunding portals. Non-accredited investors are subject to investment limits based on their annual income and net worth, with investors whose annual income or net worth is less than one hundred and seven thousand dollars limited to investing the greater of two thousand dollars or five percent of the lesser of their annual income or net worth, and investors above that threshold limited to ten percent of the lesser of their annual income or net worth up to a specified maximum per year. These investment limits are designed to prevent non-accredited investors from concentrating an excessive proportion of their limited financial resources in speculative crowdfunding investments.

Suitability Considerations for Non-Accredited Investors

For investment advisers and broker-dealers advising non-accredited investors, the regulatory framework's differentiated treatment of this investor category has important implications for suitability analysis and client service.

The investment universe accessible to non-accredited investors in the private markets is significantly more limited than that available to accredited investors, reflecting the regulatory protections described above. Investment advisers serving non-accredited investor clients must be aware of these limitations and must not recommend private investments that are not available to non-accredited investors or that would require the client to qualify as an accredited investor for participation. Recommending a Rule 506(b) or Rule 506(c) offering to a non-accredited investor, or facilitating their participation in an offering that does not meet the requirements for non-accredited investor participation, would constitute a securities law violation as well as a potential suitability violation.

The broader suitability implications of a client's non-accredited investor status relate to the concentration risk and liquidity risk considerations that apply to any recommendation of illiquid private investments to investors with more limited financial resources. Even for non-accredited investors who are eligible to participate in Regulation A or crowdfunding offerings, the adviser must carefully assess whether the investment amount relative to the client's total financial resources and liquidity needs is appropriate given the illiquid and speculative character of most private investment opportunities.

Verification of Accredited Investor Status

The determination of whether a prospective investor qualifies as an accredited investor or must be treated as a non-accredited investor is an important compliance function for issuers conducting private placements and for broker-dealers and investment advisers who facilitate client participation in such offerings.

For Rule 506(b) offerings that do not use general solicitation, issuers may rely on representations made by investors about their accredited investor status without independent verification, provided the issuer does not have reason to believe the representations are false. This self-certification approach is the most common practice for traditional private placements, where the investor completes a subscription agreement or questionnaire representing their accredited investor status and the issuer relies on that representation.

For Rule 506(c) offerings that use general solicitation, the issuer must take reasonable steps to verify that all investors are actually accredited investors rather than relying solely on investor self-certification. The SEC has provided guidance on verification methods that constitute reasonable steps, including reviewing tax returns or W-2 forms to verify income-based accreditation, reviewing bank or brokerage statements to verify net worth-based accreditation, and obtaining written confirmation from a licensed attorney, accountant, registered broker-dealer, or registered investment adviser that they have taken reasonable steps to verify the investor's accredited status within the prior three months.

Examination Relevance and Key Takeaways

The non-accredited investor concept is tested on the Series 65 examination in the context of private securities offerings, the Regulation D exemption framework, investor protection principles, and the suitability obligations applicable when advising clients on private investment opportunities. Candidates must understand the definition of a non-accredited investor as any individual or entity not meeting the accredited investor thresholds of Regulation D, the financial thresholds that separate accredited from non-accredited investors including the one million dollar net worth threshold excluding the primary residence and the two hundred thousand dollar individual or three hundred thousand dollar joint income threshold, the regulatory implications of including non-accredited investors in a Regulation D offering including the thirty-five non-accredited investor limit under Rule 506(b), the sophistication requirement for non-accredited investors, and the enhanced disclosure obligations triggered by their inclusion, and the alternative pathways for non-accredited investor participation in private capital markets through Regulation A and Regulation Crowdfunding.

The core points to retain are these: a non-accredited investor is any individual or entity failing to meet the accredited investor thresholds of one million dollars net worth excluding primary residence or two hundred thousand dollars individual income or three hundred thousand dollars joint income; the vast majority of the US population is non-accredited reflecting the regulatory judgment that most households lack the financial resources and sophistication to evaluate unregistered private investments without full disclosure protections; Rule 506(b) offerings may include up to thirty-five non-accredited investors who must be sophisticated and triggers enhanced disclosure requirements including audited financial statements comparable to registered offerings; Rule 506(c) offerings using general solicitation are restricted to accredited investors only requiring reasonable steps to verify each investor's status; Regulation A Tier 2 offerings up to seventy-five million dollars per year and Regulation Crowdfunding offerings up to five million dollars per year provide alternative pathways for non-accredited investor participation with investment limits and disclosure requirements providing investor protection; investment advisers must not recommend private investments to non-accredited investor clients where such investors are ineligible for participation; and the differentiated regulatory treatment of accredited and non-accredited investors reflects the information asymmetry, risk absorption, and liquidity arguments for providing additional protections to investors with more limited financial resources and sophistication.