If you have always wanted to invest with the “big fish” in the financial industry but never had quite enough assets to qualify for accredited investor status, the SEC’s latest update could be the best Christmas present you ever received. On December 8, 2020, the U.S. Securities and Exchange Commission (SEC)’s most recent rulings on accreditation, which were announced in August, went into effect. This meant that certain investors who previously were limited to the classification of “sophisticated” or possibly barred from certain offerings completely now can participate in a wider variety of private investments.
“The rule couldn’t come at a better time,” said Nasdaq.com contributor Milind Mehere, who is also CEO of YieldStreet. “We are living through a yield crisis where treasuries are under 1 percent and historical volatility in the stock market amidst a pandemic. Company pensions are going extinct…making it more important than ever that [investors’] money can work for them.”
Self-directed IRA investors are positioned to particularly benefit from these new developments, since owners of self-directed accounts are already more familiar with the benefits of “alternative” assets outside of the traditional stocks, bonds, and mutual funds. Although there are a few prohibited assets in which self-directed account holders cannot invest, the majority of creative and innovative deals are wide open, regardless of market sector. This helps self-directed investors diversify their retirement portfolios with both alternative investments and traditional stocks/bonds.
Accredited investors are the population of individuals, spouses, and investment companies that meet certain criteria laid out by the SEC. While many people refer to being “certified” as an accredited investor, the fact is that you do not have to apply or submit forms for approval. When investing in a prospective investment, you will likely have to show documentation that you meet the accredited investor eligibility requirements, but you will not receive any documentation from the SEC regarding your accreditation. Instead, you are simply responsible for demonstrating, upon request, that you meet the standards.
The SEC uses multiple “tests” to determine whether a person qualifies as an accredited investor. There are different tests for companies and corporations, but we will not deal with those in this article since most self-directed investors are individuals.
The SEC’s tests are designed to help the SEC and project managers determine if an investor is in good enough financial standing to make an investment and that they are likely to understand the risks involved in the investment.
There are four routes to accreditation:
If you have a pre-tax income in excess of $200,000 in each of the two most recent tax return years and have a reasonable expectation that you will earn the same or more in the current calendar year, you will likely qualify as an accredited investor.
This means that if you wanted to invest as an accredited investor in 2020, your reported income on your tax returns would need to have been higher than $200,000 in 2019 and 2018 and you would need to have a reasonable expectation of earning the same in 2020.
If you wish to qualify with your spouse, then you need a pre-tax minimum income of $300,000 or more for the two years prior.
If you have a net worth exceeding $1 million not including your primary residence, you will likely qualify as an accredited investor. If you wish to qualify with your spouse, then you would use your net worth as a couple, still excluding the value of your primary residence.
Although you cannot take a test specifically for being an accredited investor, you can leverage your professional certifications in order to qualify as an accredited investor. This is called a “knowledge test,” and it is one of the newly enacted ways investors can qualify. At present, the SEC permits individuals in good standing with Series 7, Series 65, or Series 82 licenses, which are certain types of financial securities licenses. The SEC’s ruling in August permits it to adjust, expand, or shorten this list of licenses in the future, so you must monitor this.
Have you ever heard someone say, “I know as much if not more about [fill in the blank] but I’m not allowed to do it! I know I could do a better job!” Well, the SEC may not agree that you can do someone else’s job better than that person, but the commission did decide that if you are a “knowledgeable employee” for a private fund, you probably know enough to pass muster as an accredited investor. “Knowledgeable employees” are defined as:
• Executive officers
• General partners
• Advisory board members
• A "person serving in a similar capacity" to the positions about in a private fund or as an affiliated management person
• An employee of a private fund or an affiliated management person who participates in the investment company for at least 12 months
Numbers 3 and 4 on the list are the new definitions from the SEC and, as such, are likely still developing. The SEC has left itself plenty of wiggle room with these new definitions, so savvy investors will watch their trusted news sources (like Mainstar Trust!) to make sure they have access to the latest official changes and clarifications.
Please note: Not all alternative investments require Accredited Investor status. Please review the private placement memorandum, subscription agreement, or prospectus for purchase.
Always take the time to consult with trusted, professional advisors to ensure you understand tax, legal, and investment issues related to the use of IRA funds in LLCs.