On August 26, 2020, the Securities and Exchange Commission announced the adoption of several amendments to the rules regarding the definition of an accredited investor under Rule 501 of Regulation D. The long-awaited amendments create new categories of individuals and entities that may qualify as an accredited investor and are intended to expand access to private offerings, in part by considering factors other than a natural person investor’s income or net worth. Instead, the amendments allow investors to potentially qualify as accredited investors based on factors indicative of an investor’s sophistication and financial knowledge. The amendments, which were proposed on December 18, 2019, were adopted substantially as proposed and will become effective 60 days after they are first published in the Federal Register.
Professional Certifications and Designations or Other Credentials The largest new category of accredited investors will be natural persons who hold certain professional certifications, designations, or other credentials issued from an accredited educational institution. The initial list of professional certifications and designations includes the following certifications administered by the Financial Industry Regulatory Authority, Inc. (FINRA): the Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82). Individual investors who hold these licenses and are in good standing with FINRA will qualify as accredited investors even if they do not meet the net worth or income standards historically used to establish accredited investor status for natural persons. The SEC expects to issue orders from time to time regarding which certifications, designations, or other credentials will qualify their holders as an accredited investor. As with other categories of accredited investors, issuers must take reasonable steps to verify whether an investor is accredited — in this case, verifying that the investor holds the requisite certification or designation. The SEC is encouraging issuers to verify professional designations using readily information available on FINRA’s BrokerCheck or the SEC’s Investment Adviser Public Disclosure Database.
Knowledgeable Employees of Private Funds Individuals who are “knowledgeable employees,” as defined in Rule 3c-5(a)(4) under the Investment Company Act, of a private fund now qualify as accredited investors for investments in the fund. Rule 3c-5(a)(4) remains unchanged. The category of knowledgeable employees includes trustees and advisory board members, or persons serving in a similar capacity of a Section 3(c)(1) or 3(c)(7) fund that oversees the fund’s investments and employees of the private fund who, in connection with his or her regular functions or duties, have participated in the investment activities of the private fund for at least 12 months. This change will facilitate the investment by individuals who have historically qualified as “knowledgeable employees” for Investment Company Act purposes but not as accredited investors, such as some more junior personnel, to purchase interests in their firm’s funds.
Registered Investment Advisers and Rural Business Investment Companies Investment advisers registered under Section 203 of the Investment Advisers Act and investment advisers registered under the laws of various states now qualify as accredited investors under Rule 501(a)(1) even if they are not also able to meet the $5 million assets test under Rule 501(a)(3). This amendment includes exempt reporting advisers qualified under Section 203(m) or Section 203(l) of the Investment Advisers Act in the definition of accredited investors. The expanded definition does not automatically qualify the client of registered investment advisers as accredited investors even where the registered investment adviser is exercising investment discretion on behalf of the client to the extent the client does not itself qualify as an accredited investor.
Rural business investment companies, as defined in Section 384A of the Consolidated Farm and Rural Development Act, are now included in the definition of accredited investors. These companies qualify as accredited investors based on their status alone.
Limited Liability Companies The amendments codify a long-standing SEC Staff position that limited liability companies with more than $5 million in assets and that meet the other requirements of Rule 501(a)(3) qualify as accredited investors.
Entities Owning More than $5 million in Investments The amendments also include a new “catch-all” category of accredited investors. Under the amendments, any entity will qualify as an accredited investor if (i) it owns more than $5 million in “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) and (2) it was not formed for the specific purpose of acquiring the securities offered. It should be noted that the capital requirement here differs from Rule 501(a)(3), which merely requires that an accredited investor hold $5 million in assets rather than investments. The SEC intends this category to account for any forms of entities not currently included in the existing definition of accredited investors, namely Native American tribes and governmental bodies, as well as new entity types that might be created in the future.
Family Offices Certain family offices and their family clients (as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act) may now qualify as an accredited investor based on that status. A family office will be considered an accredited investor if: (1) it has in excess of $5 million in assets under management, (2) it was not formed for the specific purpose of acquiring the securities offered, and (3) its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment. Family clients of a family office that meet the aforementioned requirements, whose prospective investment in the issuer is directed by such family office, also now qualify as accredited investors. This change provides additional comfort to some family offices investing on behalf of family members who may not have technically qualified as accredited investors, even though the investment decision was being driven by a sophisticated family office with substantial assets.
Qualified Institutional Buyer Definition The SEC also amended the definition of qualified institutional buyer in Rule 144A to avoid inconsistencies with the amendments to the accredited investor definition, and to include the entities that qualify as institutional accredited investors when these entities meet the $100 million in securities owned and invested threshold in Rule 144A. This change will allow certain entities that meet the investment level thresholds for qualified institutional buyer status but that were historically excluded from the Rule 144A market, such as many governmental bodies, to now participate in that market.