Corporate & Securities Alert
On August 26, 2020, the Securities and Exchange Commission (SEC) adopted amendments to the definition of “accredited investor,” allowing individual investors with certain financial knowledge and professional expertise to qualify as accredited investors regardless of their income or net worth. Qualifying as an accredited investor is important in unregistered private securities offerings under Regulation D, and historically individuals who did not meet certain income or worth thresholds were often barred from investing in these opportunities, regardless of their financial sophistication. The amendments also expand the list of eligible entities that qualify as accredited investors.
The amendments will open up investment opportunities for financially sophisticated individuals and other entity investors. Additionally, these revisions will broaden the pool of potential accredited investors for private offerings.
The amendments will be effective 60 days after publication in the Federal Register.
Previously, an individual only qualified as an accredited investor if he or she either (a) earned more than $200,000 annually for the past two years or more than $300,000 combined with his or her spouse, or (b) had an individual or combined net worth of more than $1 million, excluding the value of his or her home. The goal of these restrictions is to protect individuals unable to bear economic loss from riskier investments in unregistered private securities offerings. However, these requirements prevented many financially sophisticated individuals from investing in profitable opportunities and companies.
The SEC’s amendments add two new categories of individuals to the accredited investor definition and expand the current definition of accredited investor. First, individuals may now qualify as accredited investors based on certain professional certifications, designations, or credentials that the SEC may designate at its discretion. In conjunction with the amendments, the SEC designated holders in good standing of Series 7 (general securities representatives), Series 65 (investment advisor representatives), and Series 82 (private securities offering representatives) licenses as qualifying accredited investors. The amendments also give the SEC flexibility to evaluate and adjust or add to the professional certifications, designations, and credentials on an ongoing basis through future SEC orders.
The second new category of accredited investors allows “knowledgeable employees” of a private fund to qualify as accredited investors for investments in the fund. “Knowledgeable employee” is defined under Rule 3c-5(a)(4) of the Investment Companies Act, and includes people such as (a) trustees and advisory board members, or people serving in a similar capacity, of a Section 3(c)(1) or 3(c)(7) fund and (b) employees or affiliated persons of the fund (other than employees performing solely clerical, secretarial, or administrative functions), who have participated in the investment activities of the fund for at least 12 months in their regular functions or duties. This new category of accredited investor is similar to an existing category for directors, executive officers, and general partners of the issuer.
The new amendments also add the term “spousal equivalent” to the accredited investor definition, which will allow spousal equivalents to pool their finances in order to qualify as accredited investors. The SEC defines “spousal equivalent” as a cohabitant occupying a relationship like a spouse.
Additionally, the SEC amendments add new categories of entity investors that qualify as accredited investors and expand existing categories and definitions.
First, the new amendments codify a long-standing staff interpretation that limited liability companies with $5 million in assets may be accredited investors if they satisfy the other requirements of the accredited investor definition. Additionally, SEC and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) may now qualify as accredited investors.
The SEC also added a new catch-all category for any entity, including Native American tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that is not formed for the purpose of acquiring the securities being offered and that own “investments,” as defined in Rule 2a51-1 under the Investment Company Act, of more than $5 million.
Another new category of entity to qualify as an accredited investor is a family office that meets specific requirements. “Family offices” are entities established by families to manage their assets, plan for their family’s financial future, and provide other services to family members. Family offices generally do not have clients other than “family clients,” which include family members, former family members, and certain key employees of the family office. In order for a family office to qualify as an accredited investor it must have at least $5 million in assets under managements and its investments must be directed by a person who has knowledge and experience in financial and business matters so that the family office would be able to evaluate the merits and risks of the investment. Like other entity investors, a family office must not have been formed for the purpose of acquiring the securities being offered.
Amendments to QIB Definition
The SEC also made conforming changes to the definition of a “qualified institutional buyer,” or QIB, under Rule 144A. Rule 144A exempts certain resales of restricted securities to QIBs from registration. The changes to Rule 144A are meant to avoid inconsistencies between the entity types that are eligible for accredited investor status and QIB status.