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In this conversation, Sarah Florer and Roland Wiederaenders discuss the topic of accredited investors in the alternative asset space. They explore the reasons behind the restrictions on who can invest in alternative assets and the legal basis for these requirements. They highlight three reasons that limiting investment in alternative assets to accredited investors makes sense: 1) accredited investors have a higher tolerance for risk of loss, 2) accredited investors have resources to hire advisors, and 3) accredited investors can invest larger tranches of money, which supports the management of investments with a smaller group of investors. They also discuss the criteria for individual investors to be accredited, including net worth and income thresholds. In this part of the conversation, Sarah and Roland briefly touch on non-US investors and the potential for them to invest in alternative assets in the United States and highlight the importance of financial health and wealth building for individuals worldwide. They also discuss the different types of Rule 506 offerings, including 506B and 506C, and the consequences of including non-accredited investors in offerings for alternative investments. They mention the limitations on advertising for 506B offerings and the requirement for accredited investor verification in 506C offerings.
Takeaways
- Accredited investors have a higher tolerance for risk of loss and can afford to invest without jeopardizing their financial stability.
- Having resources to hire advisors is important for understanding the risks and making informed investment decisions.
- Private investments do better with a smaller group of investors, which is why the entry points are usually higher.
- Individual investors can be considered accredited based on their net worth or income levels.
- The criteria for accredited investors help protect investors and ensure the success of alternative asset investments. Non-US investors can also invest in alternative assets in the United States.
- Financial health and wealth building are common interests for individuals worldwide.
- Rule 506 offers different options for including non-accredited investors.
- 506B offerings have limitations on advertising.
- 506C offerings allow for advertising but only accept accredited investors.
- Accredited investor status must be verified in 506C offerings.
Chapters
00:00 Introduction and Background
01:27 The Importance of Accredited Investors
03:06 Reasons for Restrictions on Alternative Asset Investing
06:31 Legal Basis for Accredited Investor Criteria
10:29 Private Securities and Consumer Protection
13:01 Risk and Liquidity in Alternative Asset Investing
16:19 Managing Investments with a Smaller Group of Investors
18:16 Practical Considerations for Accredited Investors
22:21 Understanding Accredited Investor Criteria
25:55 Criteria for Accredited Investors: Net Worth and Income
26:23 Conclusion: Protecting Investors and Ensuring Success
26:45 Investing in Alternative Assets for Non-US Investors
27:31 The Global Interest in Financial Health and Wealth Building
29:11 Understanding the Different Types of Rule 506 Offerings
34:32 The Limitations of Advertising in 506B Offerings
36:10 The Consequences of Including Non-Accredited Investors
42:15 Accredited Investor Verification in 506C Offerings
Creators & Guests
Host
Roland Wiederaenders
Co-founder of the Alt Investing Made Easy podcast, investment advisor, and corporate securities attorney with expertise in private investment funds, corporate/securities issues, mergers and acquisitions, partnership structuring, and federal income tax matters. Roland is also a member of Grable Martin PLLC.
Host
What is Alt Investing Made Easy?
Join attorneys Sarah Florer and Roland Roland Wiederaenders as they navigate through the maze of market jargon and reveal the secrets of diversifying your portfolio. Whether you're a seasoned investor or taking your first step toward financial freedom, we empower you with the knowledge and insights you need to thrive in the dynamic landscape of alternative assets. Get ready to transform how you invest, inspiring a new way of thinking about your finances, and discover how to make your money work harder. Dive in with us, and let's make investing in alternative assets easy, giving you the confidence to navigate the financial landscape, one episode at a time.
Roland Wiederaenders (00:00.11)
So the whole point here is that our clients typically, when they do these private offerings of securities, they don't want a huge investor group. And so what they'll do is they'll set the minimum investment amount high enough to where they know that we're not going to have 100 investors investing what would be, I guess, 10 ,000 each. We're going to have 40 investors investing 25 each. Or maybe we have two investors that are investing 500 each.
R: Welcome to Alt Investing Made Easy, where we explore the complex world of alternative assets. I'm Roland, a securities attorney, investment advisor, and your co -host.
And I'm Sarah, an investment advisor and corporate attorney, and your other co -host. We'll guide you through real estate, private equity, and more, making complex topics accessible. Tune in for insights that empower your financial journey. Let's make Alt Investing Easy, one episode at a time.
S:
Today, Roland and I will be talking about an essential topic for understanding how or whether you can invest in this space. Today, we're talking about accredited investors. So Roland, when we talk about accredited investors, we have our reasons for that. And the most important reason is that people need to know whether they're even eligible to talk, to invest in alternative assets. And we've talked about risks and reasons why maybe you need to be a little bit more knowledgeable to actually be qualified to invest in this space.
R:
Yeah, and it seems a little unfair that these investments are restricted to a particular class of investors. And, you know, the egalitarian person in me sort of finds it offensive that these alternative assets would be restricted only to investments by wealthy people. That's really the definition of accredited investor.Roland Wiederaenders (01:56.59)It is somebody that has sufficient net worth or income level. And that's what an accredited investor really is, is just somebody that at a very high level financial evel, an individual has to have at least a net worth of a million dollars or income of at least 200,,000 on their own or 300,000 with their spouse.
For an entity investor, it's really you have to have a net worth of $5 million for the entity. There are other ways of qualifying it as well. But that's just the high level rule and what an accredited investor is. again, in most circumstances, you have to be accredited to invest in alternative assets. But there are some exceptions to that that we can talk about.
S:
Well, it seems like we have a few points to unpack here, I think. And one of them is why there is this restriction that maybe it seems on the face of it not egalitarian, but there are some legitimate reasons, including historical and also just the reality of liquidity risks and other things we discussed last time as to why there's some restrictions on whether you can invest in these kinds of assets. And then we want to talk also a little bit about what the framework is that sets it out because the framework has developed over almost, I mean, we're looking at nearly a hundred years that we've had the securities laws in place and they've obviously been updated over that time, but there's a good amount of history as to why the model we have now has worked pretty well over time and been tweaked to be improved over time. Do you want to start off just telling us what the basic legal basis is for why we use the word accredited investor at all?
R:
Well, I mean, this goes back to our discussion about private securities and we contrast those to public securities, which are registered and they're traded on the national securities exchanges. And they're the ones that most people hear about and think about when we talk about what a security is. Again, we're talking about private securities and private securities are securities that are sold and issued pursuant to registration exemptions under the US federal and state securities laws. talked about risk last time and Roland Wiederaenders (04:16.12) there are several different types of risks that are involved in investing in private securities. And I think targeting liquidity risk, we talked about how that's kind of the granddaddy of all the risks. Fraud risk is there too. That was one thing that we didn't even really cover. But when you think about liquidity risk, when you're investing in these alternative assets, you're theoretically in the investment for a long time period.
You know, it's not a publicly registered or publicly traded share of stock that I can buy today and sell tomorrow. I may be making my investment in the private securities today and I might not be able to sell it or get cash income or, you know, be able to convert it to cash for many years. And so it's really important to understand that. And so then you have to think, well, maybe there's additional analysis that I have to undertake if I'm investing in an alternative assets.
S:
I mean, I think that that's a fair thing to say. We know that the accredited investor definition is part of the regulation D, rule 506, which is part of the Securities Act of 1933. And we can put those technical, we can put those references down below.
And then the definition is pretty clear as to what an accredited investor is, whether you're an individual, whether you're investing through an entity or a trust. But at the same time, the fundamental underlying assessment of whether you fit into that category or not. Well, if you're on the cusp of it, I suppose you need specific legal advice. But really, the whole point of all of this is to protect people in a different way than the way you're protected if you're public securities investor.
And that is through making sure that you have a tolerance for losing money. That's essentially what this is, right? Or a tolerance for having your money locked up for a long time. And if you have a certain amount of money, then you have a higher tolerance for that.
S:
Well, right. And so I guess what I was thinking of, honestly, is if I'm going to be investing in something that I maybe can't sell it tomorrow and maybe I can't sell it for several years, then I really need to think about Roland Wiederaenders (06:33.174)whether that investment is good, whether it's appropriate for me, for my portfolio, whether I really understand what's going on. And so to help me determine that, I might need to hire advisors.
S:
Right. Yeah, exactly. And we help people with that determination all the time. And also, we also maybe help explain why it's such an important feature of this whole area of Alt Investing Made Easy, because if you're an investor, you need to make sure that you're making good decisions for yourself. Or if you're a promoter of a deal, you need investors who are stable. Also, if you have an investor who's not really maybe able to take the financial impact of what it takes to make your investment successful, then this could be problematic and could actually weigh on the interests of the other investors as well.
R:
really, you know, the way I see it is the first reason why we want to restrict alternative asset investing to wealthier individuals. Wealthier individuals generally have the resources to go out and hire a financial planner, hire an investment advisor, maybe hire an attorney like Sarah and me to take a look at the investment and tell them, you know, what are the risks here? Is this appropriate for me? You know, is this, are they offering market terms? Just being able to hire people to help you undertake the necessary analysis just to determine whether this is a good investment. And it's just a little different from investing in private, I mean, I'm sorry, in a registered share of stock. Because again, if you change your mind or you're not secure about the investment, I can buy it today and I can sell it tomorrow, but that's just not the case with alternative assets typically.
S:
Exactly. And you know, I do think it's fair sometimes when you're, you know,not a lawyer and you're in the process of getting advice or being told about restrictions, especially you might resist those and not appreciate them. But, you know, in this country, we have a long history of an investment culture in the public and private markets. And there's also a long history of the problems that have come from that.
So these rules are based on, you know, long experience of whether they're regulators or people in the government who make recommendations about changes or just the general, you know, economy.Roland Wiederaenders (08:55.872) economic history of our country shows that, you know, there's some sense for everybody. Just like the reason we have public exchanges that are regulated in the first place was the result of all the activities of the 1920s that led to a lot of people being seriously harmed and, you know, experiencing really serious problems through the failures of the markets at that time.
Sometimes, for me at least, I hope it helps, when people, when you think about the regulations and when you're faced with a rule that, you know, many of us don't really want to have rules imposed on us or certain kind of restrictions, let's say. But if you look at the why of it, it can help a lot. Understand why you just need to follow the steps. And in this case, I think for accredited investors, there are pretty clear rules about whether you are or not an accredited investor.
Well, the second reason why I think it's important to maybe restrict investments and alternative assets to accredited investors is the reason that you mentioned before. And when these statutes, the Securities Act of 1933, Exchange Act of 1934,there are others that we will talk about the Investment Advisors Act of 1940, Investment Company Act of 1940. Looking at the time period is really relevant. It's right around the time of the Great Depression.
R:
And these were in part at least consumer protection statutes to guard against securities fraud. And I think securities fraud was a problem back then. it still is around, fraud still gets committed. The distinction here is again, if I buy that share of stock in the public exchange, you know, the registered share of stock, I can buy it today, I can sell it tomorrow. I can buy it today. And if I find something out about the company, maybe they failed to make one of those filings that we were talking about. Maybe they failed to file their 10Q or they didn't file that 8K that's supposed to tell me about some material circumstance that happened with the company.Roland Wiederaenders (11:03.534)And I find out about it later and I'm really angry about that. And I feel like I've been defrauded. Well, I've got a couple of different options. First, know, if my, maybe I've experienced a trading loss because of whatever the deficiency, the failure to comply with the rules. And so in the end, I could just sell the share of stock. The values declined 10%. And so I buy it today for a hundred and tomorrow I have to sell it for 90.
And that bothers me.
S:
But you haven't lost everything.
R:
Well, right. And you can move quickly to recoup some of your money, if not all of it.
S: Right.
R:
And so that's a possible remedy. Again, with the alternative assets, there's no market where I can say, listen, I'm tired of this. I need to go and sell this, liquidate it, convert it to cash. It's going to be really difficult to do that with a private security because it's not registered, it's not traded in one of the exchanges. And so then your remedy there, if the company has failed somehow, committed fraud or whatever, one of your remedies is to sue them. And there are different types of lawsuits that you can bring, a breach of contract is one, securities fraud, hey, you...
told me that you were going to be investing in a multifamily property and I thought you were investing in something else. So there are different types of claims that you can bring against the manager of the alternative asset deal. But this is again the reason why this is limited to accredited investors, wealthier people have resources to enforce their contractual obligations. It's expensive to hire an attorney.You know, and just to write a demand letter for somebody that's unhappy, we might ask for, you know, a $5 ,000 retainer. And then if they say, well, how much is a full blown trial going to cost? mean, that might be 250 to $500 ,000.
There's just one final point that I wanted to talk about. It's really the third major reason why I think these investments are limited to accredited investors. it's a practical reason [Roland Wiederaenders (13:26.624)] that, you know, let's just say that we have a million dollar offering where we're representing a client that has some smallish scale commercial real estate development and they just need to raise a million dollars. Well, one thing that we think about is how big will our investor group be? And so if I need a million dollars, let's say I want to have no more than 40 investors in my investor group. And that's a big investor group. And what you have to think about is our clients, they're gonna have to answer to every one of those 40 people and they'll have continuous questions. And one thing that I've heard advised to the managers is that you will have a question almost every day until the person gets their money back. You know, they're going to be asking you, well, what's the status of the renovation on units one through 20 or what was the resolution of that, that tort claim that we had? You know, people are going to be wanting to know what the status of their investment is. And so our managers have to engage in investor relations. And so, so the whole point here is, is that our clients typically when they do these private offerings of securities, they don't want a huge investor group. And so what they'll do is they'll set the minimum investment amount high enough to where they know that we're not going to have a hundred investors investing, what would it be? I guess 10 ,000 each. We're going to have 40 investors investing 25 each, or maybe we have two investors that are investing 500 each.
S:Exactly.
R: Necessarily, we're talking about people that can write a check for $25 ,000 at least for these alternative asset investments.
S: I would say - normally we see 50 ,000, don't we?
R:Yeah, exactly. 25 is low and 50 is even low. And it really has to do with kind of the small scale nature of the deals that we work on or smallish. And we talked about size before, but this is just a practical [Roland Wiederaenders (15:45.806)] consideration for limiting these investments to accredited investors because generally you're going to be having to write a larger check. One thing that you can do with the public securities markets is the dollar cost averaging idea where every month I'm going to be setting aside $250. And so I just I buy whatever that $250 I invested in the mutual fund and over time.You know, it just I'm investing regularly like that, but it's not necessarily the way that you would be able to invest in an alternative asset.
S:
After this discussion, just as three takeaways about why we have and why having a criteria for being an accredited investor makes sense in the alternative asset space. The first one is that people with some money have a higher tolerance for losing some of that money. So you can't invest your last-I think it's called a hail Mary. You can't invest your last bit of money into an investment, right? And then a second reason is, as you discussed, that there are several reasons why you might need advisors, financial advisors, lawyers to help you understand the risks before you make an investment or to help you seek recourse if something goes wrong with an investment. So you need to be able to afford that kind of support, which is something that people with a higher net worth can usually typically afford.
And then the third reason, which is important that Roland, you just mentioned is a practical point, is, private investments do better when there is a smaller group of investors. And by nature, that means that you need to be able to put a larger chunk of money into these investments. They're not incremental like in a mutual fund or even in crowdfunding or some of the other alternative, some of the other places where one can invest money.
Also, something interesting to think about if you want to just get into the broader pictures. We're talking specifically here about restrictions on who can invest in alternative assets because people need to know about it. But I don't want to have us overemphasize this as a negative because it's actually a positive. And actually, if you are not yet a person who meets the criteria for alternative investing, but you are a determined investor, and I'd hope [Roland Wiederaenders (18:06.048)] all young people today have the opportunity to learn about this as early as possible and start building their wealth as early as possible, you start in the public markets. This is where your financial advisor comes into place. You start to build wealth in the equity markets, for example, the publicly traded equity markets, and that's where you can start to build up the net worth that you need. Or obviously, as many people have, you have the goal of increasing your income so that you have an income that meets the criteria for this.
But let's actually roll in. Why don't we talk a little bit more about the details of accredited investor? Because there is a category of non accredited investors who can also invest in a very limited manner in certain offerings for alternative investments. And then there's even another type of super category that we could talk about separately, maybe in more detail another day. So maybe we can move on because essentially what people want to understand is why is this
requirement for an accredited investor there and what do I do to understand if I am one or I'm not or what do I need to aspire to become an accredited investor so I can invest in alternative assets?
R: Yeah, sure. And I mentioned it real briefly at the beginning, but the rule for individual investors is that you have to have, to be accredited, you have to have at least a net worth of a million dollars. There's a couple...asterisks that you have to be aware of there. In the past, you have been able to include in that million dollar calculation the value of your principal residence. But that is something that's been done away with a couple years ago. And the idea here is that it's the incredible run up in the real estate markets. You might be house rich, but still not have
some of these resources to hire advisors, to enforce your rights, to meet the minimum investment requirements. So they eliminated the ability to include the value of your home to get to the million dollar calculation.
S:
And that's actually, I think that's so important. I just want to emphasize that point because a lot of us in this country, we are quite, can be [Roland Wiederaenders (20:26.738)] have turned out to be quite house rich in certain contexts, but that money doesn't exist until you sell that house and you still need someplace to live. In certain distinct circumstances, you can consider that easily translatable into your net worth. But for the majority of people, if you sell one valuable house, you still have to pay a significant amount of money for the next house if you're staying in the same area. it turns out that it's great to have the value in your primary residence, and historically, that's where many, I think of us had most of our value tied up. But now, as we know, as the economy goes forward, that's not necessarily enough anymore. So again, that's another reason why we really like this alternative asset space, it, Roland? Because this is how you start to build things on the side of what you know or what you have in terms of your primary residence.
R:
Yeah, that's a really good point. And worth noting, too, is that there are more recent changes that require you to include certain indebtedness in that net worth and calculation. And we don't want to get off too far into the weeds, but that is something that you want to look at is, if you've incurred debt recently, that may be counted against your million dollar measurement.
S:
Right. And that makes sense, doesn't it? Because if you've got some current debts that you're going to need to pay one way or another and something happens to your income stream, it comes from your net worth, right? So that would be a fair deduction, let's say, from how you calculate your net worth.
R:
The second way that an individual investor can be accredited is through income. You have at least $200 ,000 of income from whatever you do toyour income producing activities, your job, your business, or it can be $300 ,000 when you combine it with your spouse. So you're both making $150 in your jobs and while neither one of you hit that $200 ,000 minimum combined, you have the $300 ,000 threshold.
S:
And that's gross, right? That's just outright. That's not anything [Roland Wiederaenders (22:41.282)] post -tax or anything. yeah, yeah, I would. It's what you are going to have to. I mean, we can get into this and documenting it. There's there's different requirements depending on what exemption is being relied on. generally, or with one type, you just check a box. And so we can't counsel anybody to lie. But if you do have to document your income by reference to written third party information, which you have to do in some 506 offerings, it's just, it is the gross amount. So you show up with a 1099 or a W2 and what's reported there. mean, they report withholding, of course, but the box one typically shows a gross amount.
S:
So there's actually, know what, Roland, we can get to this another episode, I think, but there's another category too of people who can invest in alternative assets. And those are people that are non -resident, non -US citizens. And that's a whole other topic. So I don't want to get into it, but I just want to mention it here for the sake of completeness.
R:
Well, no, Sarah, it's really good. I wasn't even thinking about that, but it's good to bring that up because, know, that's one of the reasons why I like working with you so much. You have this international component and Hari lives in Dubai still and you have relations in India. And so there may be people outside the U .S. that would be watching us on this and they're thinking, boy, I'm interested in investing in alternative assets in the United States as well. And you can. And even a lot of our clients, right? We know that a lot of our clients are, let's say, first generation immigrants or people who've come here and worked really hard and built private wealth for themselves and invest in this space. And they have {Roland Wiederaenders (24:36.006)] You know, they're here fully and all of those things legally and all that here in the United States and committed to that. But they have a lot of family probably back in their home countries and in other places and who might be also doing that same journey in a different way in those places. Because one thing I would say is that, you know, everyone in the world, we all have a common interest here. And that is our financial health and survival.
R:Right.
S:
And so some people have the opportunity to do much more with it and to build much more wealth than others. But everybody in the world, I think, is on a journey to making sure that they have what they need for their family today and their future. You know, in other parts of the world, people are wealth building and often with commercial property and even similar types of assets, structures as alternative assets. But I do think that the clarity of the laws that we have here in the United States have supported us as a population for a longer time in going on this journey. And the rest of the world looks to our market for good opportunities to invest, but also looks to our laws to develop laws and other places that kind of seek to create a similar effect as what we have here in terms of our economy and our investing environment. It's, you know, all eyes are on the US in certain regards. And certainly when it comes to the securities laws of the United States, they've had really broad influence across the world.
R:
So just to kind of close the point about non -US investors, really everything that we talk about here, unless we note otherwise, as we're trying to do here, really what we're talking about rules applicable to US investors. for non -US investors, it's actually easier to qualify your eligibility to invest if you're a non -US investors. There's two...pretty simple requirements under Reg S and for most of our offerings, they're automatically satisfied. So it's good to note that and it for sure is a way, you know, a non -US investor can invest even if they're not accredited.
S:
Exactly. And this is a framework that we wanted to set out, right? So we mentioned Regulation D, now we're talking about Rule 506, and now we're talking about specific sections of Rule 506.
[Roland Wiederaenders (26:51.182)] So you want to set those out for us, Roland?
R:
Yeah, historically, and this was before 2013, and I've referenced this a couple of times, some dramatic changes in the securities laws took place, and it was the 2013 Jobs Act. But historically, for a Reg D offering, there was only one rule 506. But now there's two rule 506s. It's 506B and 506C. I bet a lot of our audience members are going to be familiar with these. For rule 506, the traditional offering that really existed for a long time, you were able to accept money from a practically unlimited number of accredited investors and up to 35 non -accredited investors, but there is a specific requirement for the non -accredited investors that must be satisfied. And that is? Well, people use a word sophisticated, and that's not actually used in the securities laws, but it's a good way to refer to people because the actual language that's used is that if you're not accredited and you want to be one of these 35 people that can invest in a 506B offering,then you have to have sufficient knowledge in business and financial matters so as to be able to evaluate the relative risks and merits of the investment for yourself. And so that just means that you have to know what a private security is, all the things that we've been talking about. You're not investing your last $10 ,000, but maybe you don't have that net worth of a million or the income, but you know about the investment, maybe you're an expert in whatever the private company is, or you're friends with the hedge fund manager and you really trust them. And so you'd much rather give them money than put it into the public markets. So there is a way for that.
S:
And it's a really critical way, isn't it Roland? Because let's not ever overlook the fact that many businesses that are gigantic today got their start because somebody [Roland Wiederaenders (29:10.488)] put money in who was a close friend and family member or who was, didn't meet the criteria of an already wealthy person and took a chance on an idea. And then you ended up with some of the biggest names we have today, right? Or at least got them started so they could get their next levels of funding in the more established ways that startups get funded.
R:
Yeah, that's exactly right. And we said that from the very beginning, that the thing that kind of inspires us in our practice is the idea of democratization of capital and no good ideas should fail for lack of funding. So the laws don't actually get in the way of that. It's just that there's some limitations that are put on the party offering in the investment. If you want to be able to include non -accredited investors or what we might you know, call sophisticated investors just so we have a word for it, really. People, that's what people use.
S:
So Roland, do you want to talk to us a little bit about the consequences of including non -accredited investors in your investment structure?
R:
Yeah, this is an important point, Sarah. And as I mentioned, there were some changes in the law in 2013 that created two 506 exemptions, B and C. And B is the old school exemption. It's the one that's existed for a really long time. And it's the one that allowed you to include the non -accredited but sophisticated investors in your investor group.
The requirement though is that offers of the securities could only be made to people that you had a substantive pre -existing relationship with. Right, right. And so what that means is the only people that I could take investment dollars from were people that I knew from other contexts other than trying to sell them securities. And these can be my friends, my business associates.
Roland Wiederaenders (31:07.596) This requirement of the substantive nature of the relationship means that there's been a certain amount of time that's passed since you've known the person. well, I guess that's really more pre -existing is it has to do with the amount of time that's passed since you've known the person. And then substantive more is what you really know about them. Do you know that this person has experience investing in private securities? Do you know that they understand that they can't just immediately log into their online brokerage account and sell the securities? Do they really understand what it is that they're getting into? They're not investing their last $10 ,000. So that's the 506B. And this is really important because historically, you've been really limited as to who you can accept investment dollars from. you typically have to think about it as people that you had pre -existing relationships with.
And then there's this other requirement that you may not use general solicitation. General solicitation is a technical term, but really you can think about it as advertising. So you cannot use any communication in connection with the offer of securities that's publicly available, like a newspaper. Nowadays, we know what really is publicly available is all the information that we can get through the internet.
So just to finish out this discussion about the different types of 506 offerings, we've talked about 506B that allows for up to 35 non -accredited investors. And practically, there is a limitation on the number of accredited investors. It's really going to be 500. And once you hit that 500 investor number, and have included non -accredited investors in your group, then you're subject to the Exchange Act reporting requirements. And we talked about that before, and you kind of have like a halfway publicly registered share of stock. It's not freely tradable, but you have these reporting obligations that we talked about under the Exchange Act. So you would have to start filing the 10Qs, the 10Ks and the 8Ks. So you wouldn't have the benefits of the public markets, .Roland Wiederaenders (33:27.278) But really, practically speaking, to have a group of 500 private investors, mean, that would be fairly unheard of. That would be extremely difficult to manage. We talked before about a group of 40 investors, and this is something we talk with our clients about. We warn them against having too big of a group. But in any event, 506B allows you to take the non -accredited investor money and you can't use advertising. So that's a really simple way of saying it.
So in 2013 though, rule 506C came about and with the 506C offering, you can use advertising, you can use general solicitation. And people are, I'm sure our audience have seen these investment opportunities on their LinkedIn feed or their Facebook feed. It'll say something like, invest in Central Texas real estate. They'll click on it. And what it is is a 506C offering a private securities through the internet. The requirement though for a 506C.
S:
There's always going to be a requirement for that, right? catch. So yes, you get to advertise, but what's the catch?
R:
Yeah.The catch is that you can't include any non -accredited investors in the offering. You can only accept money from accredited investors.
S:
So, Roland, what are the consequences of having non -accredited investors as part of your investor group?
R:
Well, that's a really good question, and it kind of goes back to the changes that happened in 2013 with these two exemptions. And historically, there was just one Rule 506 exemption.
And it allowed for a practically unlimited number of accredited investors and up to 35 non -accredited investors. But the requirement there is that you could only make offers, you could only accept investment dollars from people that you had a pre -existing substantive relationship with. So the way that you made offers, the way that you made people aware about the investment opportunity, [Roland Wiederaenders (35:37.376)] it had to be limited to people that you knew ahead of time outside of the context of trying to sell securities to them.
S:
Maybe we can actually maybe for another episode get into more details about all of that because I do think we get a lot of questions from clients about how do you determine if you know somebody already and to what degree do you need to know them. And if you think generally like, if this were the friends and families exception, you should probably know them for a while and know enough about them to know if they can be a good investor for you or not, or if they're basically a safe investor. But there is a more technical approach to analyzing that that might be something we could talk about in further detail later.
R:
What I'd love to be able to say is you have to be an accredited investor to invest in a private security. And the reason for that is that 80 % of the effort that our managers have to put forth in their investor relations are dedicated to the non -accredited investors. It's just a kind of a rule that the accredited investors are generally more knowledgeable. They're not as nervous about making this investment that constitutes a smaller percentage of their overall portfolio. And then from a practical standpoint, you know, it's just you're not gonna be able to raise as much money from a non -accredited investor as you can from an accredited investor. Otherwise, they would be accredited, right? Even if they're a friend and family. But like you said, there are tons of businesses that got started by people investing, and they have this substantive pre -existing relationship, but they were investing because they're friends and family. They really believed in the business, and they wound up becoming wildly successful. So there are instances where it's appropriate and for sure it's allowed and you just have to make sure that the person is sophisticated like we mentioned before. And again, the definition there is you have to have sufficient knowledge and business and financial matters in order to be able to determine the relative risks and merits of the investment that you're making.
S:
Exactly.Roland Wiederaenders (37:54.836).And, you know, I guess when we are talking in this webcast, we're trying to speak to everyone in a certain extent or to two different, we're speaking to investors and we're also speaking to people who are seeking investors. So we, and I think we do that on purpose, don't we, Roland, because we think if you are an investor, it's great for you to understand the point of view of the promoters of the investments you're interested in. And if you are a promoter, it's important for you to understand, you know, the trends or investments or issues that arise for the investors and being in our position as advisors that we see both sides all the time. So I guess some of what we can share is sort of our views on what we've learned over time about being in between those two at one side or the other, depending on the situation. But moving on, we've talked about rule 506B. But then there's now the new rule 506C. And this sounds very exciting at the outset.
R:
Well, yeah. And I think it does have some great potential and we're for sure capitalizing on this because historically, we couldn't talk about private securities offering a place where... I can't remember if we had talked about general solicitation before, but I'm going to go ahead and...
and mention that because that's one of the requirements for the old school when what is now the 506B is that you cannot use general solicitation in connection with the offer of securities. And what that means is advertising. And as we know nowadays, all advertising or so much advertising goes through the internet. And what we're really doing here is we're using the internet to sell securities pursuant to rule 506C.
S: Right.
R:
But the price that you have to pay for 506C and your ability to use advertising is that you can only take money from accredited investors.
S: the catch.
R:
their status as being accredited must be verified by reference to written third party information. That's a simplification, but that's the general rule. That's how everybody should think about it is that you have to prove that you're an accredited investor. With the 506B, all you had to do is check a box. I'm an accredited investor. Roland Wiederaenders (40:09.384)
And unless the manager, the sponsor of the deal knew otherwise, actually had actual knowledge that you weren't accredited, they can take that representation from you. They just have to form a reasonable belief that you're accredited.
S:
Right. So then this is maybe a key point. And we've heard this, interestingly, sometimes in the context of people that are very high net worth, don't want to share their financial information. So by reference to third party information basically means that to prove your accredited investor status, you have to share some private financial data about yourself that might be there. There are a lot of details that to get into here. But really, in general, you're talking about bank statements, proof of wages or proof of earnings that as you would report to the tax authorities, as would be reported by an employer or another party to the tax authorities about you and, you know, your brokerage statements, other things that you might have. And so in that context, some people don't want to do that. Some people are completely comfortable with that because they're, you know, accustomed to all of this. But this is a point and this is part of the catch of the third party information.
R:
Yeah. And just two observations about that is that since 2013, I've really noticed that people are more and more comfortable providing this information. Right. You know, they're just used to it now. They hear it more as just like, well, this is a requirement for the offering and they understand the reasons why.
S:
Right. you know what, think also third party providers, banks, brokerages, you know, they're all set up better to support people in this. And as you proceed with building wealth, you know, very high net wealth individuals often have to have proof of their status for a lot of different contexts. And so it just becomes more and more normal as you proceed through all of this that sometimes that information is shared. And of course, you know, you require confidentiality of the parties that you're sharing it with.
R:
Well, yeah, for sure. And that is something that our managers know to do is they take this information in solely for the purpose of qualifying the investor. And the other thing is if people are sensitive about providing their personal financial information, one way of verifying your status by reference to a written third party information is just by getting a letter from your accountant [Roland Wiederaenders (42:33.302)]or your attorney, if the deal ever gets examined, you know, and this will only happen if the deal goes south where people lose money and they call up the securities board here in Texas, that's the securities regulator, the Texas state securities board, or maybe they call the SEC and they're big enough losses to where the regulator gets interested in looking into it. And the first question they'll ask is what exemption did you rely on? And if the person says 506C because we used advertising,
Then the next question after that is, okay, well, let me see all the investor files and I need to see that written third party information. So for sure our clients need to maintain, you know, that verification information in their files.
S:
Now that we've established that you need to understand for yourself if you're able to invest in alternative assets or not. And one of the determinations to make is, I an accredited investor or not? That can be a complicated determination depending on your facts, in which case you need to rely on legal advice or generally legal advice is what we would say. But generally speaking, we're giving out the guideposts here of what it means to be an accredited investor and what the consequences are if you are or you're not. So in the end, under the rule 506, there is a possibility to be an accredited investor and there are certain requirements that come if..you know, you're an accredited investor and how that offering is offered and what restrictions there may or may not be. And then you have the non -accredited investors who can invest in some contexts. So in summary, what would you say the takeaways are here, Roland? If you're, you know, why is this area important?
R:
Well, I think it's always important to understand why these rules are in place so that, you know, you can work within them. And the other is to to really understand that if you look at the growth of the changes in 2013 and then changes that have happened subsequent to 2013 to these rules, this really does, these changes to the rules really illustrate what I believe is a mega trend. I'm not the only person that thinks this, but I really do think that the SEC is trying to democratize capital. I really think that there's an effort [Roland Wiederaenders (44:55.086)]
on their part to try to change the rules so that more people can invest in private securities. And I can give a couple examples of those changes. The first one is that a couple years ago, the SEC changed the rules so that you could be an accredited investor if you pass the Series 65 or the Series 7. These are securities licensing exams for investment advisors and broker dealers. And so if you have one of those but you don't have the minimum net worth or income requirements, then you qualify as an accredited investor. And the whole idea there is that if you pass one of those exams, then you have, you're necessarily, you have that sufficient knowledge and information experience in financial and business matters to be able to evaluate the risks for yourself. And then even going beyond that,there was a proposed rule over the last couple of years that the SEC was going to create its own examination that you could take. And if you pass that test, then you were an accredited investor. And I think that's really great because, know, what we'll get into, I hope we can get into a discussion at some point about why an investment in alternative assets can be, it can be the best investment option that's available, period.
And I really believe that. it doesn't mean that all alternative assets are the very best investments, just like, you know, all stocks aren't the very best investment. You have to be selective. But there really are good investment opportunities and private securities and alternative assets. And the fact that the SEC is aware of this and they want to be able to give people access to good investment opportunities. I mean, that makes me feel like, you know, there's a lot to be critical of in our government. We don't want to really be political here in any way, but it makes me feel good to think that the SEC is aware of this issue and they're trying their, I guess their very best to try to make these investments accessible.
S:
And I just want to add to that Roland that again, when we're here in this country, we get very focused on how things are here and what we think we do or don't have. But when you take a broader approach and look at [Roland Wiederaenders (47:15.884)]you know, many countries in the world and how you might go about a similar journey. There are a lot of restrictions that people face. There are lot of expenses to investing, especially in a private way in other places. And as a result, the wealth stays very concentrated and not the wealthy that we're talking about here, where having a million dollars net worth definitely qualifies you as a wealthy person. But we're talking about very high net worth individuals who end up with even more of the eggs in their own baskets because of the barriers to entry and the lack of democratization of capital. And this is a whole area that I feel very passionate about because I want people in this country, because I've worked in other regions in the world where you see all of this. And it's very, very important to me to just have the perspective shared that, yes, you may feel like things are unfair. You may not like regulations in the United States and no system is perfect. But when it comes to
private individuals starting from the bottom and building their private wealth from the bottom up. This country does support that and the laws support that and our institutions, whether it's a conscious policy of an institution to support democratization of capital or whether it's something we share culturally, it's something that's really important and recognized as really important and valuable. And we actually do have tools for that. And I think we want to get into that more and more because this is our introductory series, right? We're just mentioning a lot of different topics here that are important and we're going to keep coming back to all of these so that it really sinks in for people that anybody can understand all of these things so that they can, know, wherever they are in building their wealth, whether it's at the beginning, the middle, or so far away from, you know, the way where they started, that they have more information to use and maybe new perspectives to think about how that journey is going.
Just to wrap up, we started off with the original question, how do I know if I'm an accredited investor or not? We tried to explain why there is such a status or such a definition and discuss some of the issues around that and then set out the framework for how you determine if you are or not and some of the consequences of whether you are or are not an accredited investor. So what we hope to send people away with this time [Roland Wiederaenders (49:37.37)]
is an understanding that there's a reason for why there's a certain limitation on who can invest in alternative assets. There are different routes to go about investing in alternative assets depending on the status of the investors. And so there are considerations from whether you're an investor or whether you're a promoter of an investment. And in the end, it's something that when you get into a lot of detail, of course, it becomes complicated.
Overall, you can start to understand for yourself where you might sit in terms of that scope and then what kind of alternative investing you might want to start exploring with your financial advisor.
R:
So in wrapping up, we've had a good discussion today about the accredited investor rules. And if you've liked this video, we'd ask that you hit the like button, subscribe to our channel, and remember to take aim with your alternative asset investing.
Thanks everybody for joining us and we'll see you next time on Alt Investing Made Easy.