On December 18, 2019, the Securities and Exchange Commission (SEC) proposed amendments to the definition of “accredited investor” to add new categories of natural persons and entities that would qualify under the rule and also to make certain other modifications to the existing definition in Regulation D. According to the proposed rule release, the amendments are intended to “update and improve the definition in order to identify more effectively institutional and individual investors that have the knowledge and expertise to participate in our private capital markets and therefore do not need the additional protections of registration under the Securities Act of 1933.” The SEC press release announcing the proposed changes is available here and the proposed rule release is available here.
Currently, the test for who can qualify as an individual accreditor investor only takes into account an individual’s income or net worth and specifically includes (i) any natural person whose individual net worth, or joint net worth with that person's spouse, excluding their primary residence, exceeds $1 million and (ii) any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
The proposed amendments would expand the scope to allow for considerations of professional knowledge, experience or certifications, thereby allowing for more natural persons to qualify as individual accreditor investors. Specifically, the proposal would now allow for natural persons to qualify based on (1) certain professional certifications or designations or other credentials (including a series 7, 65 or 82 license), or (2) their status as a private fund’s “knowledgeable employee”.
The SEC is also proposing to expand the scope of entities that may qualify as accredited investors. The first such change is to address some long overdue updating. Historically, the most common means for an entity to qualify as an accredited investor has been section 501(a)(3), which applies to a corporation, trust or partnership with total assets in excess of $5 million. Notably absent from this definition is a limited liability company, a legal entity which came into existence after Regulation D was adopted. The proposal addresses this omission by adding limited liability company to the list in section 501(a)(3).
In addition, registered investment advisers, rural business investment companies, and “family offices” are all proposed to be included in the types of entities qualifying as accredited investors. The “family offices” entity category requires family offices to have at least $5 million in assets under management and would only apply to a family office whose purchase is directed by an individual that has financial and business knowledge and experience.
The proposed rule also includes a new approach to defining entities that qualify as accredited investors. This investments-owned test is meant to serve as a catch-all by including all types of entities not already encompassed within Rule 501(a), such as Indian tribes, labor unions, governmental bodies and funds, and entities formed under the laws of a foreign country, so long as such entity owns investments in excess of $5 million and was not formed for the specific purpose of acquiring the securities being offered. The SEC believes that entities with this level of investments should have as much financial sophistication as other institutional accredited investors.
The SEC is also proposing that natural persons can include joint income from spousal equivalents (a cohabitant occupying a relationship generally equivalent to that of a spouse) when calculating joint income under Rule 501(a)(6) and net worth under Rule 501(a)(5). This is to clarify the lack of a definition for “spouse” in Rule 501 and to provide clarity for persons in legally recognized unions, such as domestic partnerships.
In addition to expanding the scope of accredited investor, the SEC is also proposing to amend the “qualified institutional buyer” definition in Rule 144A, by allowing for rural business investment companies, limited liability companies, and entities that meet a $100 million in securities owned and invested threshold that qualify for accredited investor status to qualify as qualified institutional buyers.
By expanding the scope of “accredited investor” and “qualified institutional buyer”, the SEC is taking steps to modernize the securities laws to reflect developments in business practices and in society since the adoption of Regulation D.
The public comment period will remain open for 60 days following publication of the proposed rule release in the Federal Register.