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Industry Voices

Phoenix American: The Definition of Sophisticated

By September 22, 2018No Comments

The Trump administration promised to expand the base of investors with access to alternatives or PDIs (Portfolio Diversifying Investments). The way to achieve this is to revise the definition of an “accredited investor”. An understanding of the current accreditation rules reveals the significance of possible changes.

The Securities Act of 1933 limits participation in PDIs to “accredited” or “sophisticated” investors. The current definition of accredited investor dates to 1982 with no review or revision conducted since. There are reasons to update the definition:

  • To expand the investor pool and facilitate capital formation for companies looking to innovate and expand.
  • To establish a logical and modern definition of “sophisticated” Investor.
  • To expand access to an asset class long denied to knowledgeable individuals.


The act defines an accredited investor as either:

  • a person with an income of $200,000 per year (or a couple with a combined income of $300,000 per year) or
  • a person or couple with a net worth of $1 million or more.


The rule presumes the investment sophistication of individuals based solely on arbitrary 36-year-old monetary thresholds. Investors below these thresholds may not participate in most alternatives.

The 12.4 million accredited investors in the U.S. control three-quarters of the country’s wealth, roughly $65 trillion, according to Seeking Alpha. The rule, however, excludes a large population of investors who would be considered “sophisticated” under any probative definition. Their access to PDIs would benefit investors and sponsors alike.

One proposal is to expand the current accredited investor definition to include those with active licenses in financial services industry organizations: the Financial Industry Regulatory Authority (FINRA), the Chartered Financial Analyst (CFA) Institute, certified public accountants (CPAs), etc. This small definitional change would expand the potential investor pool for PDIs by nearly 1.4 million or 11%. Licensed financial professionals are certainly sophisticated investors though their average salary as a group is well below the $200,000 income currently required. Other categories of licensed financial professionals could also be included, perhaps real estate brokers and attorneys.

Another proposal is to develop a meaningful test to determine the sophistication of investors who do not meet either the financial threshold or the “Active License” requirement.

The ”JOBS and Investor Confidence Act of 2018” which includes the “Fair Investment Opportunities for Professional Experts Act” (which already passed overwhelmingly by the House) is a bi-partisan bill likely to pass into law. Under this law, the definition of accredited investor would be “an individual determined by the Securities and Exchange Commission (SEC) to have qualifying education or experience.” The SEC would have latitude to establish a sensible modern definition allowing a larger qualified population to take advantage of opportunities in PDIs.

Investors in PDIs should be accredited but there is no doubt that the definition begs for an update. Licensing requirements across the regulated financial services industry demand sophistication. PDIs have always played a key role in asset allocation for pensions, endowments and foundations.  Sophisticated investors deserve the same ability to diversify their portfolios.


Post contributed by: Phoenix American Financial Services, Inc., an IPA member company.