SEC Issues Final Rule Amending Definition of “Accredited Investor”September 3, 2020
The Securities and Exchange Commission (“SEC”) has issued a final rule (the “Rule”) revising the definition of “accredited investor” under Regulation D promulgated under the Securities Act of 1933 (the “1933 Act”) [Click for link], which definition had remained largely unchanged for the past thirty-five years.
According to the SEC, the Rule amendments are intended to update and improve the “accredited investor” definition “to identify more effectively investors that have sufficient knowledge and expertise to participate in investment opportunities that do not have the rigorous disclosure and procedural requirements, and related investor protections, provided by registration under the 1933 Act.”
Below is a summary of the significant updates from the Rule.
Expansion of “Accredited Investor” Definition
The Rule expands the definition of “accredited investor” to include all of the following:
Designated Professionals. Persons holding in good standing one or more professional certificates, designations or credentials from an accredited educational institution that the SEC has designated as qualifying. The initial approved certifications include the Financial Industry Regulatory Authority, Inc. (“FINRA”) Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82) certifications. The SEC can expand this list in the future, subject to public notice and comment.
“Knowledgeable Employees.” As defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940 (the “Investment Company Act”), of a private-fund issuer of the securities being offered or sold. This includes the executive officers, directors, trustees, general partners, advisory board members, or persons serving in a similar capacity, of a fund exempt from registration as an investment company under Section 3(c)(1) or 3(c)(7) of the Investment Company Act, or an employee or affiliated management person of such fund (other than an employee performing solely clerical, secretarial or administrative functions) who, in connection with such employee’s regular duties, has participated in the investment activities of such fund for at least 12 months.
Investment Advisers. SEC- and state-registered investment advisers, and exempt reporting advisers under Section 203(m) or Section 203(l) of the Investment Advisers Act of 1940 (the “Investment Advisers Act”).
Rural Business Investment Companies (“RBICs”). As defined in Section 384A of the Consolidated Farm and Rural Development Act.
Family Offices and Family Clients. “Family offices,” as defined under the Investment Advisers Act, having in excess of $5 million in assets under management, provided that (i) the family office not be formed for the specific purpose of acquiring the securities offered and (ii) the prospective investment is directed by a person who has such knowledge and experience in financial and business matters such that the family office is capable of evaluating the merits and risks of the prospective investment. “Family clients”—e.g., family members, former family members and certain key employees—of any family office meeting the expanded definition, are also included.
Other Entities Meeting $5 Million Investment Threshold. Certain other entities, including tribal governments, governmental bodies, and foreign entities and funds that own investments in excess of $5 million, as long as these entities are not formed for the purpose of investing in the particular securities offered.
Other Miscellaneous Accredited Investor Updates
Spousal Equivalent. The Rule adds the term “spousal equivalent” to the definition of accredited investor. “Spousal equivalent” is defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse.” Now, under the joint income and net worth tests for individual accredited investors, spousal equivalents may pool their finances. Assets need not be held jointly to be included in the calculation.
LLCs and their Managers. The Rule codifies the SEC’s previous guidance that limited liability companies meeting the $5 million asset test and other conditions of Rule 501(a)(3) are accredited investors. The SEC, in its release commentary, also offered its interpretation that managers of limited liability companies are included in the definition of “executive officer.”
Entity v. Natural Persons. The Rule clarifies that in determining accredited investor status under Rule 501(a)(8) (i.e., an entity of which all equity owners are accredited investors), an issuer may look through various forms of equity ownership to natural persons. If all those natural persons are themselves accredited investors, the requirements of Rule 501(a)(8) would be satisfied.
Rule 163B. The SEC is also amending Rule 163B to incorporate a slightly modified version of the new “accredited investor” definition for purposes of “test-the-waters” communications. Rule 163B allows issuers to gauge market interest in a possible initial public offering or other registered securities offering through discussions with certain institutional investors prior to, or following, the filing of a registration statement.
Expansion of “Qualified Institutional Buyer” Definition
The Rule also amends the term “qualified institutional buyer” (“QIB”) used in Rule 144A. Under the new definition, limited liability companies and RBICs may qualify as QIBs if they own and invest at least $100 million in securities of non-affiliated issuers. Additionally, the new Rule adds a “catch-all” category under the QIB definition, whereby investors who meet the definition of accredited investor, but are of a form not otherwise enumerated in the QIB definition, may qualify if they also satisfy the $100 million threshold.
No Changes to Existing Dollar Thresholds
While acknowledging receipt of public comments cutting both ways during the rulemaking process, at this time the SEC declined to revise the current dollar thresholds under the existing income, net worth and asset test elements of the existing accredited investor definition.
What This Means for Our Clients
The Rule’s amendments are part of the SEC’s broader effort to simplify, harmonize, and improve the exempt offering framework under the 1933 Act to promote capital formation and expand investment opportunities while maintaining and enhancing appropriate investor protections. By expanding the pool of potential accredited investors and QIBs, markets should see an increase in the potential funding available in private and Rule 144A offerings. Issuers may find it easier to identify and attract potential participants in these types of offerings. In response to the new Rule, issuers who routinely participate in offerings of these types should revisit their subscription/purchase agreements, investor questionnaires and other offering documents accordingly.
The Rule becomes effective 60 days after publication in the Federal Register.
Only institutions (and not natural persons) who are clients of a “family office” qualify as “accredited investors” under Rule 163B.