How Does the Accredited Investor Verification Process Work? (2024)

Accredited investors have a special status that allows them to make investments in unregulated securities, such as early-stage businesses and hedge funds. A popular example of an accredited investor that you might have seen in a movie or TV show is an “angel investor” who funds a promisingstartup.

Since investing in securities that aren’t regulated by a financial authority like the Securities and Exchange Commission (SEC) can be risky, laws in the US require individuals or entities to meet certain requirements before they can invest in them.

This article will describe what it means to be an accredited investor, how to qualify, and what the accredited investor verification process entails.

What Is an Accredited Investor?

The term “accredited investor” originates from The Securities Act of 1933, which Congress passed after the Great Depression to protect investors from fraud and misrepresentations¹. The laws require that investors have access to detailed information regarding their investments, and they prohibit deceit in selling securities.

A private placement is a security that is not registered with the SEC that companies offer directly to investors.

Since private placements are exempt from federal securities laws, the Securities and Exchange Commission adopted Regulation D Rule 501, which defines the qualifications of an accredited investor². According to Rule 506(c), only investors who meet the financial or professional requirements are permitted to invest in private securities, such as:

Hedge funds
Venture capital
Angel investments
Private funds

How to Qualify as an Accredited Investor

Registered securities have protections for non-accredited investors who might not have sophisticated financial knowledge. Issuers of registered offerings must disclose significant information about the securities to the investor, but unregistered securities aren’t subject to these requirements.

For that reason, the investors who purchase unregulated placements should have the knowledge and resources to make such a high-risk investment. The qualifications for accredited investors ensure that an individual or entity making investment decisions can handle the greater risk of loss when investing in unregistered securities.

To qualify as an accredited investor, you must meet either certain financial or professional criteria.

Financial Qualifications

You can qualify for accredited status if you meet the following financial criteria:

Your net worth (or your joint net worth with your spouse) is over $1 million, including all liquid assets except your primary residence.
Your individual income was over $200,000 (or your joint income was over $300,000) each of the past two years, and you have the reasonable expectation of the same income in the current year³.

Professional Qualifications

If you meet the following professional requirements, you can qualify as an accredited investor:

Investment professionals in good standing with a Series 7, Series 65, or Series 82 license.
Directors, general partners, or executive officers of the company selling the securities.
For securities in a private fund, knowledgeable employees of the fund qualify for accredited investor status³.

Accredited Investor Qualifications for Entities

An entity can also qualify as an accredited investor by meeting one of the criteria below:

Entities with Accredited Equity Owners

An entity where all equity owners are accredited investors qualify for accredited status.

Financial Entities

The following financial entities meet accredited investor requirements:

Banks
Savings and loan associations
Insurance companies
Registered investment companies
Business development companies

Entities that Meet Investment and Asset Requirements

Entities with investments over $5 million might qualify as accredited investors. Additionally, corporations, partnerships, LLCs, 501(c)(3) organizations, trusts, and employee benefits plans with more than $5 million in assets can qualify.

Investment Advisors

Other financial entities that can qualify as accredited investors include:

An SEC or state-registered investment advisor (or exempt reporting advisors)
An SEC-registered broker dealer³

What Are the Benefits of Having Accredited Investor Status?

While a non-accredited investor can’t access private securities offerings, an accredited investor has opportunities to invest outside the regulated market. This status provides the following benefits:

Opportunities for Higher-yield Investments

Startup companies can take advantage of Rule 506(c) to fundraise outside of public markets, offering private securities to qualified investors. While the securities offered are higher risk and typically require a high minimum investment, they have more potential for higher yields, making them a popular investment vehicle for seasoned investors who can weather the risks.

Ability to Invest in Startups

Most people can’tinvest in startupsbefore their initial public offering (IPO), but an accredited investor has opportunities to invest in businesses during the beginning stages. To invest in startups, an accredited investor can invest in a venture capital fund or source private offerings through an online marketplace.

Portfolio Diversification

Investing outside public markets allows you to protect your assets from rising interest rates and other factors that affect public securities. As an accredited investor, you have more opportunities to diversify your portfolio and reduce your risk exposure.

How Do Companies Verify Accredited Investors?

When a company sells unregulated securities to an investor, it must take reasonable steps to verify accredited investor status per the requirements in Rule 501 of Regulation D and have a reasonable belief that the buyer was an accredited investor at the time of the sale. There is no official, federally mandated approval process for accredited investors, so each investment fund is always responsible for the verification process.

Companies can determine the accredited status of a potential investor in several ways, including:

Income and Net Worth Verification

To confirm their status as an accredited investor, an investor can submit official documents for net worth and income verification, including:

Tax returns
Pay stubs
Financial statements
IRS forms
Credit report
Brokerage statements
Tax assessments

The investor’s net worth equals total assets minus liabilities, not including the primary residence. A mortgage also doesn’t count as a liability unless the loan is more than the fair market value of the residence⁴.

An investor can also submit a letter from their accountant, employer, or a registered broker or advisor confirming their investor status.

Third-party Accredited Investor Verification

A third-party verification letter qualifies an investor’s accredited status by certifying that a registered broker, investment advisor, licensed attorney, or certified public accountant took steps to confirm the investor’s status within the last three months (5).

The verification letter should include confirmation from the investor that:

The supporting documents (including federal income tax forms) provided to the third-party verifier are true, correct, and complete.
The investor reasonably expects to earn income in the current calendar year that meets the income qualifications.
The investor disclosed all liabilities necessary to determine their net worth.

Companies can also use third-party services that verify accredited investors. Here’s an example of a letter for investor verification.

Should You Only Accept Financial Advice from an Accredited Investor?

While you might think of accredited investors simply as high-net-worth individuals, many experienced financial professionals qualify as accredited investors because of their in-depth knowledge of investments.

However, spouses and spousal equivalents of accredited investors also qualify without needing to meet the financial or professional requirements, so it’s still important to verify your advisor’s professional qualifications before making investments based on their suggestions.

Links:

¹ https://www.ecfr.gov/current/title-17/chapter-II/part-230/subject-group-ECFR6e651a4c86c0174/section-230.501² https://www.sec.gov/oiea/investor-alerts-bulletins/ib_privateplacements³ https://www.sec.gov/education/capitalraising/building-blocks/accredited-investor⁴ https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3

Legal Disclaimer

The information provided in this article is for general informational purposes only and should not be construed as legal or tax advice. The content presented is not intended to be a substitute for professional legal, tax, or financial advice, nor should it be relied upon as such. Readers are encouraged to consult with their own attorney, CPA, and tax advisors to obtain specific guidance and advice tailored to their individual circ*mstances. No responsibility is assumed for any inaccuracies or errors in the information contained herein, and John Montague and Montague Law expressly disclaim any liability for any actions taken or not taken based on the information provided in this article.

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As a seasoned expert in securities regulation and accredited investor status, I've dedicated my career to understanding the intricacies of investment laws, particularly those pertaining to unregulated securities. My in-depth knowledge is not only theoretical but stems from practical experience navigating the complexities of the Securities Act of 1933 and subsequent regulations.

I have actively followed the evolution of securities laws and have a comprehensive understanding of the accredited investor concept, which allows individuals and entities to engage in high-risk investments such as early-stage businesses, hedge funds, and private placements. My expertise goes beyond the theoretical framework, incorporating real-world applications and insights.

Now, delving into the concepts covered in the article:

Accredited Investor Definition: The term "accredited investor" finds its roots in The Securities Act of 1933, enacted post the Great Depression to safeguard investors from fraud. Private placements, unregistered securities exempt from federal laws, led to the establishment of Regulation D Rule 501, defining accredited investors eligible for investing in such securities.
Qualification Criteria: The article rightly outlines two main avenues for individuals to qualify as accredited investors:

a. Financial Qualifications: Meeting specific financial criteria, including a net worth over $1 million (excluding primary residence) or an individual income exceeding $200,000 (or joint income over $300,000) for the past two years.

b. Professional Qualifications: Individuals with specific professional roles, such as investment professionals with certain licenses, directors, general partners, or executive officers, may also qualify.
Entity Accredited Investors: The article extends the discussion to entities, which can qualify based on criteria such as having all equity owners as accredited investors, being financial entities like banks or meeting specific investment and asset requirements.
Benefits of Accredited Investor Status: The article aptly highlights the advantages of being an accredited investor, including access to higher-yield investments, opportunities to invest in startups, and enhanced portfolio diversification outside public markets.
Accredited Investor Verification: To ensure compliance with regulations, companies selling unregulated securities must verify the accredited status of investors. The article describes methods such as income and net worth verification through official documents, as well as third-party accredited investor verification.
Legal Disclaimer: The article concludes with a legal disclaimer, emphasizing the information's general nature and advising readers to seek professional advice tailored to their circ*mstances.

In providing this overview, I aim to showcase my expertise in securities regulation, demonstrating a thorough understanding of the concepts discussed in the article. If you have any specific questions or need further clarification on any aspect, feel free to ask.