Last week, the U.S. Securities and Exchange Commission (SEC) proposed new rules to expand and clarify the definition of "accredited investor" under the U.S. Securities Act of 1933. Among other things, the rules would open private equity markets to a potentially wider group of individuals and entities, including many investment firm employees, thereby aligning the interests of such investment professionals and investors.
The accredited investor definition serves as a key threshold for individuals and entities to participate in private equity, venture capital, and other private capital investments without the disclosure burdens associated with offerings to a wider audience of investors. Currently, the definition limits investment to individuals with (i) a net worth (or joint spousal net worth) of US$1 million or (ii) annual income of US$200,000 (or US$300,000 jointly) and entities (i) with total assets of at least US$5 million or (ii) in which all the equity holders are accredited investors.
The proposed rules do not fundamentally alter the eligibility requirements for private equity investments. In aggregate, however, they provide welcome clarity to several aspects of the definition. For private fund sponsors who raise capital in the United States, the proposed rules will incorporate certain qualified professionals as accredited investors, notwithstanding net worth or annual income. In addition, the proposed rules will make it easier for a firm’s junior investment professionals to participate in their firms' investment funds.
Among other things, the SEC proposes as follows:
- Natural persons who have certain professional designations, including who have obtained certain licenses administered by the North American Securities Administrators Association (NASAA) would automatically qualify as accredited investors.
- Natural persons who are "knowledgeable employees" would automatically qualify as accredited investors, eliminating a vexing inconsistency with rules under the U.S. Investment Company Act of 1940 (the Company Act). The proposed rules eliminate this long-standing incongruity by incorporating the Company Act's Rule 3c-5 definition of "knowledgeable employee" (i.e. executive officers and employees who participate in investment activities of the fund) into the accredited investor definition.
- The SEC also clarifies that the newly defined "spousal equivalents" (i.e. anyone in domestic partnerships, civil unions and the like) should be treated as spouses for purposes of the definition, and the SEC would loosen the rules to clarify that the net worth of each individual spouse (or spousal equivalent) would count toward the net worth test.
The full proposed rules can be found here. Note that the comment period ends 60 days after publication of the proposed rules in the Federal Register. At this point, it is difficult to predict whether or when these rules would be formally put into effect.