What’s the Difference Between ‘Accredited Investors’ and ‘Qualified Purchasers’?
There's no one-size-fits-all template for investments when it comes to creation, monitoring, and disclosures to participants.
In the United States, many of these functions are stipulated by each state, various Congressional laws, and the Securities and Exchange Commission. These agencies seek to balance protection of investors with compliance costs.
And as with most governmental efforts, involvement of various agencies creates some interesting outcomes and confusing terms.
Oversight balancing acts
The many investments intended for the masses come with high fixed costs for set-up and monitoring, as well as heavy unbending disclosure requirements. However, many smaller investments simply could not be established in this way because the cost of compliance would be more than the investment itself.
In recognition of this, certain regulation changes carved out exceptions. However, less monitoring and disclosure in these vehicles increases the possibility of fraud and investor losses.
Accredited investor intricacies
Governments then sought to restrict investments in these exceptions to “sophisticated investors.”
Rather than administering a licensing test or a process to assess an investor's level of education or sophistication, governments simply instituted some arbitrary net worth and income levels. These limits assume competence in investment selection, although there certainly are plenty of examples of people with large sums money and no sophistication.
This level of assets or income test is sometimes known as the “Accredited Investor” standard.
U.S. investor guidelines
There are global differences for when a person is considered an Accredited Investor.
In the United States, different rules apply to individuals, corporations, trusts, charities, and other entities. The designations are too lengthy to discuss here, but the specifics are defined in Rule 501 of Regulation D by the U.S. Securities and Exchange Commission (SEC).
Guidelines for an individual U.S. investor state that person is an Accredited Investor when he has either:
- Net-worth (assets minus liabilities) in excess of $1 million excluding the value of your primary residence, or
- Income of at least $200,000 each year for the last two years ($300,000 combined if married) and the expectation of that continuing this year.
Companies can then set-up to raise capital from individuals without issuing registered securities under “Reg D.” Once done, they must limit their offering to Accredited Investors.
Analysis is imperative
Another more stringent requirement in U.S. investing comes from the 1940 Investment Company Act 3(c)1 exemption, which adds the term “Qualified Purchaser” to the list. Again, there are various rules for entities, but for an individual to be considered a Qualified Purchaser, he must have a minimum of $5 million in investable assets.
Ultimately, many privately held companies, real estate projects, and hedge funds are operated via these mechanisms.
Any investor navigating these waters should take extra caution in his analysis knowing that there is less disclosure and monitoring by the government, meaning the time-honored warning, ‘buyer beware,’ certainly applies. Engaging with a qualified wealth management advisor who is experienced with non-traditional assets can yield a better understanding of an investment’s pros and cons, and help mitigate associated risks.