An 8-K is a report of unscheduled material events or corporate changes at a company that could be of importance to the shareholders or the Securities and Exchange Commission (SEC). Also known as a Form 8K, the report notifies the public of events, including acquisitions, bankruptcy, the resignation of directors, or changes in the fiscal year.
Key Takeaways
The SEC requires companies to file an 8-K to announce significant events relevant to shareholders.
Companies have four business days to file an 8-K for most specified items.
Public companies use Form 8-K as needed, unlike some other forms that must be filed annually or quarterly.
Form 8-K is a valuable source of complete and unfiltered information for investors and researchers.
Understanding Form 8-K
An 8-K is required to announce significant events relevant to shareholders. Companies usually have four business days to file an 8-K for most specified items.
Investors can count on the information in an 8-K to be timely.
Documents fulfilling Regulation Fair Disclosure (Reg FD) requirements may be due before four business days have passed. An organization must determine if the information is material and submit the report to the SEC. The SEC makes the reports available through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) platform.
The SEC outlines the various situations that require Form 8-K. There are nine sections within the Investor Bulletin. Each of these sections may have anywhere from one to eight subsections. The most recent permanent change to Form 8-K disclosure rules occurred in 2004.
Benefits of Form 8-K
First and foremost, Form 8-K provides investors with timely notification of significant changes at listed companies. Many of these changes are defined explicitly by the SEC. In contrast, others are simply events that firms consider to be sufficiently noteworthy. In any case, the form provides a way for firms to communicate directly with investors. The information provided is not filtered or altered by media organizations in any way. Furthermore, investors do not have to watch TV programs, subscribe to magazines, or even wade through financial news websites to get the 8-K.
Form 8-K also provides substantial benefits to listed companies. By filing an 8-K in a timely fashion, the firm’s management can meet specific disclosure requirements and avoid insider trading allegations. Companies may also use Form 8-K to notify investors of any events that they consider to be important.
Finally, Form 8-K provides a valuable record for economic researchers. For example, academics might wonder what influence various events have on stock prices. It is possible to estimate the impact of these events using regressions, but researchers need reliable data. Because 8-K disclosures are legally required, they provide a complete record and prevent sample selection bias.
Criticism of Form 8-K
Like any legally required paperwork, Form 8-K imposes costs on businesses. There is the cost of preparing and submitting the forms, as well as possible penalties for failing to file on time. Although it is only one small part of the problem, the need to file Form 8-K also deters small companies from going public in the first place. Requiring companies to provide information helps investors make better choices. However, it can reduce their investment options when the burden on businesses becomes too high.
Requirements for Form 8-K
The SEC requires disclosure for numerous changes relating to a registrant’s business and operations. Changes to a material definitive agreement or the bankruptcy of an entity must be reported. Other financial information disclosure requirements include the completion of an acquisition, changes in the firm’s financial condition, disposal activities, and substantial impairments. The SEC mandates filing an 8-K for the delisting of a stock, failure to meet listing standards, unregistered sales of securities, and material modifications to shareholder rights.
An 8-K is required when a business changes accounting firms used for certification. Changes in corporate governance, such as control of the registrant or amendments to articles of incorporation, need to be reported. Changes in the fiscal year and modifications of the registrant’s code of ethics must also be disclosed.
The SEC also requires a report upon the election, appointment, or departure of a director or specific officers. Form 8-K must be used to report changes related to asset-backed securities. The form may also be used to meet Regulation Fair Disclosure requirements.
Form 8-K reports may be issued based on other events up to the company’s discretion that the registrant considers to be of importance to shareholders.
Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes summarizing, analyzing, and reporting these transactions to oversight agencies, regulators, and tax collection entities. The financial statements used in accounting are a concise summary of financial transactions over an accounting period, summarizing a company’s operations, financial position, and cash flows.
Key Takeaways
Regardless of the size of a business, accounting is a necessary function for decision making, cost planning, and measurement of economic performance.
A bookkeeper can handle basic accounting needs, but a Certified Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks.
Two important types of accounting for businesses are managerial accounting and cost accounting. Managerial accounting helps management teams make business decisions, while cost accounting helps business owners decide how much a product should cost.
Professional accountants follow a set of standards known as the Generally Accepted Accounting Principles (GAAP) when preparing financial statements.
Accounting is an important function of strategic planning, external compliance, fundraising, and operations management.
Investopedia / Jiaqi Zhou
How Accounting Works
Accounting is one of the key functions of almost any business. It may be handled by a bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of employees at larger companies. The reports generated by various streams of accounting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions.
The financial statements that summarize a large company’s operations, financial position, and cash flows over a particular period are concise and consolidated reports based on thousands of individual financial transactions. As a result, all professional accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical accounting experience.
History of Accounting
The history of accounting has been around almost as long as money itself. Accounting history dates back to ancient civilizations in Mesopotamia, Egypt, and Babylon. For example, during the Roman Empire, the government had detailed records of its finances. However, modern accounting as a profession has only been around since the early 19th century.
Luca Pacioli is considered “The Father of Accounting and Bookkeeping” due to his contributions to the development of accounting as a profession. An Italian mathematician and friend of Leonardo da Vinci, Pacioli published a book on the double-entry system of bookkeeping in 1494.
By 1880, the modern profession of accounting was fully formed and recognized by the Institute of Chartered Accountants in England and Wales. This institute created many of the systems by which accountants practice today. The formation of the institute occurred in large part due to the Industrial Revolution. Merchants not only needed to track their records but sought to avoid bankruptcy as well.
The Alliance for Responsible Professional Licensing (ARPL) was formed in August 2019 in response to a series of state deregulatory proposals making the requirements to become a CPA more lenient. The ARPL is a coalition of various advanced professional groups including engineers, accountants, and architects.
Types of Accounting
Accountants may be tasked with recording specific transactions or working with specific sets of information. For this reason, there are several broad groups that most accountants can be grouped into.
Financial Accounting
Financial accounting refers to the processes used to generate interim and annual financial statements. The results of all financial transactions that occur during an accounting period are summarized in the balance sheet, income statement, and cash flow statement. The financial statements of most companies are audited annually by an external CPA firm.
For some, such as publicly-traded companies, audits are a legal requirement. However, lenders also typically require the results of an external audit annually as part of their debt covenants. Therefore, most companies will have annual audits for one reason or another.
Managerial Accounting
Managerial accounting uses much of the same data as financial accounting, but it organizes and utilizes information in different ways. Namely, in managerial accounting, an accountant generates monthly or quarterly reports that a business’s management team can use to make decisions about how the business operates. Managerial accounting also encompasses many other facets of accounting, including budgeting, forecasting, and various financial analysis tools. Essentially, any information that may be useful to management falls underneath this umbrella.
Cost Accounting
Just as managerial accounting helps businesses make decisions about management, cost accounting helps businesses make decisions about costing. Essentially, cost accounting considers all of the costs related to producing a product. Analysts, managers, business owners, and accountants use this information to determine what their products should cost. In cost accounting, money is cast as an economic factor in production, whereas in financial accounting, money is considered to be a measure of a company’s economic performance.
Tax Accounting
While financial accountants often use one set of rules to report the financial position of a company, tax accountants often use a different set of rules. These rules are set at the federal, state, or local level based on what return is being filed. Tax accounts balance compliance with reporting rules while also attempting to minimize a company’s tax liability through thoughtful strategic decision-making. A tax accountant often oversees the entire tax process of a company: the strategic creation of the organization chart, the operations, the compliance, the reporting, and the remittance of tax liability.
The Accounting Profession
While basic accounting functions can be handled by a bookkeeper, advanced accounting is typically handled by qualified accountants who possess designations such as Certified Public Accountant (CPA) or Certified Management Accountant (CMA) in the United States.
In Canada, the three legacy designations—the Chartered Accountant (CA), Certified General Accountant (CGA), and Certified Management Accountant (CMA)—have been unified under the Chartered Professional Accountant (CPA) designation.
A major component of the accounting professional is the “Big Four”. These four largest accounting firms conduct audit, consulting, tax advisory, and other services. These firms, along with many other smaller firms, comprise the public accounting realm that generally advises financial and tax accounting.
Careers in accounting may vastly difference by industry, department, and niche. Some relevant job titles may include:
Auditor (internal or external): ensures compliance with reporting requirements and safeguarding of company assets.
Forensic Accountant: monitors internal or external activity to investigate the transactions of an individual or business.
Tax Accountant: strategically plans the optimal business composition to minimize tax liabilities as well as ensures compliance with tax reporting.
Managerial Accountant: analyzes financial transactions to make thoughtful, strategic recommendations often related to the manufacturing of goods.
Information and Technology Analyst/Accountant: maintains the system and software in which accounting records are processed and stored.
Controller: oversees the accounting functions of financial reporting, accounts payable, accounts receivable, and procurement.
As of December 2021, the average Certified Public Accountant in the United States made $101,779 per year.
The Accounting Rules
In most cases, accountants use generally accepted accounting principles (GAAP) when preparing financial statements in the U.S. GAAP is a set of standards and principles designed to improve the comparability and consistency of financial reporting across industries. Its standards are based on double-entry accounting, a method in which every accounting transaction is entered as both a debit and credit in two separate general ledger accounts that will roll up into the balance sheet and income statement.
In most other countries, a set of standards governed by the International Accounting Standards Board named the International Financial Reporting Standards (IFRS) is used.
Tax accountants overseeing returns in the United States rely on guidance from the Internal Revenue Service. Federal tax returns must comply with tax guidance outlined by the Internal Revenue Code (IRC). Tax accounts may also lean in on state or county taxes as outlined by the jurisdiction in which the business conducts business. Foreign companies must comply with tax guidance in the countries in which it must file a return.
Special Considerations
Accountants often leverage software to aid in their work. Some accounting software is considered better for small businesses such as QuickBooks, Quicken, FreshBooks, Xero, SlickPie, or Sage 50. Larger companies often have much more complex solutions to integrate with their specific reporting needs. This includes add-on modules or in-home software solutions. Large accounting solutions include Oracle, NetSuite, or Sage products.
The Accounting Cycle
Financial accountants typically operate in a cyclical environment with the same steps happening in order and repeating every reporting period. These steps are often referred to as the accounting cycle, the process of taking raw transaction information, entering it into an accounting system, and running relevant and accurate financial reports. The steps of the accounting cycle are:
Collect transaction information such as invoices, bank statements, receipts, payment requests, uncashed checks, credit card statements, or other mediums that may contain business transactions.
Post journal entries to the general ledger for the items in Step 1, reconciling to external documents whenever possible.
Prepare an unadjusted trial balance to ensure all debits and credits balance and material general ledger accounts look correct.
Post adjusting journal entries at the end of the period to reflect any changes to be made to the trial balance run in Step 3.
Prepare the adjusted trial balance to ensure these financial balances are materially correct and reasonable.
Prepare the financial statements to summarize all transactions for a given reporting period.
Cash Method vs. Accrual Method of Accounting
Financial accounts have two different sets of rules they can choose to follow. The first, the accrual basis method of accounting, has been discussed above. These rules are outlined by GAAP and IFRS, are required by public companies, and are mainly used by larger companies.
The second set of rules follow the cash basis method of accounting. Instead of recording a transaction when it occurs, the cash method stipulates a transaction should be recorded only when cash has exchanged. Because of the simplified manner of accounting, the cash method is often used by small businesses or entities that are not required to use the accrual method of accounting.
Imagine a company buys $1,000 of inventory on credit. Payment is due for the inventory in 30 days.
Under the accrual method of accounting, a journal entry is recorded when the order is placed. The entry records a debit to inventory (asset) for $1,000 and a credit to accounts payable (liability) for $1,000. When 30 days has passed and the inventory is actually paid for, the company posts a second journal entry: a debit to accounts payable (liability) for $1,000 and a credit to cash (asset) for $1,000.
Under the cash method of accounting, a journal entry is only recorded when cash has been exchanged for inventory. There is no entry when the order is placed; instead, the company enters only one journal entry at the time the inventory is paid for. The entry is a debit to inventory (asset) for $1,000 and a credit to cash (asset) for $1,000.
The difference between these two accounting methods is the treatment of accruals. Naturally, under the accrual method of accounting, accruals are required. Under the cash method, accruals are not required and not recorded.
The Securities and Exchange Commission has an entire financial reporting manual outlining reporting requirements of public companies.
Why Accounting Is Important
Accounting is a back-office function where employees may not directly interface with customers, product developers, or manufacturing. However, accounting plays a key role in the strategic planning, growth, and compliance requirements of a company.
Accounting is necessary for company growth. Without insight into how a business is performing, it is impossible for a company to make smart financial decisions through forecasting. Without accounting, a company wouldn’t be able to tell which products are its best sellers, how much profit is made in each department, and what overhead costs are holding back profits.
Accounting is necessary for funding. External investors want confidence that they know what they are investing in. Prior to private funding, investors will usually require financial statements (often audited) to gauge the overall health of a company. The same rules pertain to debt financing. Banks and other lending institutions will often require financial statements in compliance with accounting rules as part of the underwriting and review process for issuing a loan.
Accounting is necessary for owner exit. Small companies that may be looking to be acquired often need to present financial statements as part of acquisition or merger efforts. Instead of simply closing a business, a business owner may attempt to “cash-out” of their position and receive compensation for building a company. The basis for valuing a company is to use its accounting records.
Accounting is necessary to make payments. A company naturally incurs debt, and part of the responsibility of managing that debt is to make payments on time to the appropriate parties. Without positively fostering these business relationships, a company may find itself with a key supplier or vendor. Through accounting, a company can always know who it has debts to and when those debts are coming due.
Accounting is necessary to collect payments. A company may agree to extend credit to its customers. Instead of collecting cash at the time of an agreement, it may give a customer trade credit terms such as net 30. Without accounting, a company may have a hard time keeping track of who owes it money and when that money is to be received.
Accounting may be required. Public companies are required to issue periodic financial statements in compliance with GAAP or IFRS. Without these financial statements, a company may be de-listed from an exchange. Without proper tax accounting compliance, a company may receive fines or penalties.
Example of Accounting
To illustrate double-entry accounting, imagine a business sends an invoice to one of its clients. An accountant using the double-entry method records a debit to accounts receivables, which flows through to the balance sheet, and a credit to sales revenue, which flows through to the income statement.
When the client pays the invoice, the accountant credits accounts receivables and debits cash. Double-entry accounting is also called balancing the books, as all of the accounting entries are balanced against each other. If the entries aren’t balanced, the accountant knows there must be a mistake somewhere in the general ledger.
What Are the Responsibilities of an Accountant?
Accountants help businesses maintain accurate and timely records of their finances. Accountants are responsible for maintaining records of a company’s daily transactions and compiling those transactions into financial statements such as the balance sheet, income statement, and statement of cash flows. Accountants also provide other services, such as performing periodic audits or preparing ad-hoc management reports.
What Skills Are Required for Accounting?
Accountants hail from a wide variety of backgrounds. Generally speaking, however, attention to detail is a key component in accountancy, since accountants must be able to diagnose and correct subtle errors or discrepancies in a company’s accounts. The ability to think logically is also essential, to help with problem-solving. Mathematical skills are helpful but are less important than in previous generations due to the wide availability of computers and calculators.
Why Is Accounting Important for Investors?
The work performed by accountants is at the heart of modern financial markets. Without accounting, investors would be unable to rely on timely or accurate financial information, and companies’ executives would lack the transparency needed to manage risks or plan projects. Regulators also rely on accountants for critical functions such as providing auditors’ opinions on companies’ annual 10-K filings. In short, although accounting is sometimes overlooked, it is absolutely critical for the smooth functioning of modern finance.
The term accountant refers to a professional who performs accounting functions such as account analysis, auditing, or financial statement analysis. Accountants work with accounting firms or internal account departments with large companies. They may also set up their own, individual practices. After meeting state-specific educational and testing requirements, these professionals are certified by national professional associations.
Key Takeaways
An accountant is a professional who performs accounting functions such as account analysis, auditing, or financial statement analysis.
Accountants can find employment with an accounting firm or a large company with an internal accounting department, or they can set up an individual practice.
Many accountants choose to become Certified Public Accountants because the CPA designation is considered the gold standard in the accounting profession.
Understanding Accountants
Accountants are financial professionals who take charge of a series of accounts—either private or public. These accounts may be owned by either a corporation or individuals. As such, they may find work with corporations of different sizes—small to large—governments, different organizations like non-profits, or they may set up their own private practice and work with individuals who enlist their services.
They perform multiple accounting duties which vary based on where they work. Accountants perform account analysis, review financial statements, documents, and other reports to ensure they are accurate, conduct routine and annual audits, review financial operations, prepare tax returns, advise on areas that require more efficiencies and cost-savings, and provide risk analysis and forecasting.
An accountant’s duties often depend on the type of educational background and designation they receive. Most professionals in the field possess bachelor’s degrees and—if employed by a corporation—may require certification to move up within the firm. Certification requirements vary, with some roles requiring additional educational requirements above the bachelor’s degree and successful completion of rigorous examinations. Accountants can have more than one designation. But the most common accounting designations are the Certified Internal Auditor (CIA), Certified Management Accountant (CMA), and Certified Public Accountant (CPA). A Certified Internal Auditor doesn’t need to receive any license in order to practice, and neither do Certified Management Accountants.
Although your accountant may have more than one designation, the most common are Certified Internal Auditor, Certified Management Accountant, and Certified Public Accountant.
Many accountants choose to become CPAs because the designation is considered the gold standard in the accounting profession. In the United States, certification requirements for accountants can vary from state to state. But there is one requirement that is uniform in every state—the passing of the Uniform Certified Public Accountant Examination. This is an exam that is written and graded by the American Institute of Certified Public Accountants (AICPA).
Special Considerations
Accountants must abide by the ethical standards and guiding principles of the region where they practice, such as the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP). The IFRS is a set of rules issued by the International Accounting Standards Board (IASB). These rules promote consistency and transparency in financial statements. GAAP, on the other hand, is a set of standards that accountants must adhere to when they complete financial statements for any publicly-traded companies.
Certified public accounts are legally and ethically responsible to be honest, trustworthy, and to avoid negligence in their duties. CPAs have real influence over their clients, which means their judgment and work can affect not just an individual but an entire company—including its employees, its board, and its investors. Accountants may be held liable for paying uninsured losses to creditors and investors in the case of a misstatement, negligence, or fraud.
Accountants can be held liable under two different types of law—common law and statutory law. Common law liability includes negligence, fraud, and breach of contract, while statutory law includes any state or federal securities laws.
History of Accountants
The first professional association for accountants, the American Association of Public Accountants, was formed in 1887, and CPAs were first licensed in 1896. Accounting grew as an important profession during the industrial revolution. This was largely due to the fact that businesses grew in complexity and the shareholders and bondholders, who were not necessarily a part of the company but were monetarily invested, wanted to know more about the financial well-being of the companies they were invested in.
After the Great Depression and the formation of the Securities and Exchange Commission (SEC), all publicly traded companies were required to issue reports written by accredited accountants. This change increased the need for corporate accountants even further. Today, accountants remain a ubiquitous and crucial part of any business.
An accredited investor is an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities. They are entitled to this privileged access by satisfying at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.
In the U.S., the term accredited investor is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include high-net-worth individuals (HNWIs), banks, insurance companies, brokers, and trusts.
Key Takeaways
Accredited investors are those individuals classified by the SEC as qualified to invest in complex or sophisticated types of securities.
To become accredited certain criteria must be met, such as having an average yearly income over $200,000 ($300,000 with a spouse or domestic partner) or working in the financial industry.
Sellers of unregistered securities are only allowed to sell to accredited investors, who are deemed financially sophisticated enough to bear the risks.
Accredited investors are allowed to buy and invest in unregistered securities as long as they satisfy one (or more) requirements regarding income, net worth, asset size, governance status, or professional experience.
Unregistered securities are considered inherently riskier because they lack the normal disclosures that come with SEC registration.
Understanding Accredited Investors
Accredited investors are legally authorized to purchase securities that are not registered with regulatory authorities like the SEC. Many companies decide to offer securities to this class of accredited investors directly. Because this decision allows companies exemption from registering securities with the SEC, it can save them a lot of money.
This type of share offering is referred to as a private placement. It has the potential to present these accredited investors with a great deal of risk. Therefore authorities need to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.
When companies decide to offer their shares to accredited investors, the role of regulatory authorities is limited to verifying or offering the necessary guidelines for setting benchmarks to determine who qualifies as an accredited investor. Regulatory authorities help determine if the applicant possesses the necessary financial means and knowledge to take the risks involved in investing in unregistered securities.
Accredited investors also have privileged access to venture capital, hedge funds, angel investments, and deals involving complex and higher-risk investments and instruments.
Requirements for Accredited Investors
The regulations for accredited investors vary from one jurisdiction to the other and are often defined by a local market regulator or a competent authority. In the U.S, the definition of an accredited investor is put forth by SEC in Rule 501 of Regulation D.
To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.
A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. This amount cannot include a primary residence. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.
An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.
If a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they too can qualify to be considered an accredited investor.
Recent Changes to the Accredited Investor Definition
Recently, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors.
On Aug. 26, 2020, the U.S. Securities and Exchange Commission amended the definition of an accredited investor. According to the SEC’s press release, “the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”
Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.
Purpose of Accredited Investor Requirements
Any regulatory authority of a market is tasked with both promoting investment and safeguarding investors. On one hand, regulators have a vested interest in promoting investments in risky ventures and entrepreneurial activities because they have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may be focused on concept-only research and development activities without any marketable product, and may have a high chance of failure. If these ventures are successful, they offer a big return to their investors. However, they also have a high probability of failure.
On the other hand, regulators need to protect less-knowledgeable, individual investors who may not have the financial cushion to absorb high losses or understand the risks associated with their investments. Therefore, the provision of accredited investors allows access for both investors who are financially well-equipped, as well as investors who are knowledgeable and experienced.
There is no formal process for becoming an accredited investor. Rather, it is the responsibility of the sellers of such securities to take a number of different steps in order to verify the status of entities or individuals who wish to be treated as accredited investors.
Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to respond to a questionnaire to determine if the applicant qualifies as an accredited investor. The questionnaire may require various attachments: account information, financial statements, and a balance sheet to verify the qualification. The list of attachments can extend to tax returns, W-2 forms, salary slips, and even letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Additionally, the issuers may also evaluate an individual’s credit report for additional assessment.
Example of an Accredited Investor
For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000. While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual’s primary residence. Net worth is calculated as assets minus liabilities.
This person’s net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.
Who Qualifies to Be an Accredited Investor?
The SEC defines an accredited investor as either:
an individual with gross income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
a person whose individual net worth, or joint net worth with that person’s spouse or partner, exceeds $1,000,000, excluding the person’s primary residence.
Are There Any Other Ways of Becoming an Accredited Investor?
Under certain circumstances, an accredited investor designation may be assigned to a firm’s directors, executive officers, or general partners if that firm is the issuer of the securities being offered or sold. In some instances, a financial professional holding a FINRA Series 7, 62, or 65 can also act as an accredited investor. There are a few additional methods that are less relevant, such as somebody managing a trust with more than $5 million in assets.
What Privileges Do Accredited Investors Receive That Others Don’t?
Under federal securities laws, only those who are accredited investors may participate in certain securities offerings. These may include shares in private placements, structured products, and private equity or hedge funds, among others.
Why Do You Need to Be Accredited to Invest in Complex Financial Products?
One reason these offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain bouts of volatility or the risk of large losses, thus rendering unnecessary the regulatory protections that come from a registered offering.
What If I Lie About Being an Accredited Investor?
It is both your responsibility to represent yourself truthfully when opening a financial account, as well as the financial company itself to do its complete due diligence to ensure you are telling the truth (e.g., asking for tax returns or bank/brokerage statements to verify income or assets). This means that a non-accredited investor who loses money on a complex financial instrument may be able to recover some of their losses, even if they did lie about their status.
The Bottom Line
The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand. But on the flip side, it gives people already starting off with large financial assets a major advantage over those with more modest assets.
