SEC Expands the Definition of Accredited Investors: Action Required
On August 26, 2020, the Securities and Exchange Commission (the “SEC”) adopted previously proposed amendments (the “Amendments”) that expand the definition of “accredited investor” (or “AI”) applicable to private placements under Regulation D, and the definition of “qualified institutional buyer” (or “QIB”) under Rule 144A, each under the Securities Act of 1933, as amended (the “Securities Act”). The Amendments were published in the Federal Register on October 9, 2020 and will be effective on December 8, 2020, and can be found here.
The changes are relevant to every issuer who offers securities in a “private placement” including public and private companies, hedge funds, private equity funds and venture capital funds. With the Amendments, certain persons who were not previously considered “accredited investors” will now qualify under the broadened definition. The new categories in the definition are meant to capture additional investors that have “sufficient knowledge and expertise to participate in investment opportunities” of exempt securities offerings. The Amendments are part of the SEC’s effort to “simplify, harmonize and improve” the private offering framework, and are substantially similar to those in the SEC’s December 2019 proposal.
- Before December 8, 2020, private fund managers and other issuers that conduct private offerings should consider updating subscription agreements, offering documents, and other documents, policies and procedures to reflect the changes to the AI and, if applicable, QIB definitions.
- Private fund managers and other issuers that conduct private offerings should also consider if any employees who, prior to the Amendments, were unable to invest in funds under management or in the company will now qualify under the expanded category for knowledgeable employees.
Key Parts of the Amendments
- Adds new categories of “accredited investor” definition for natural persons to include:
- Individuals with certain professional credentials, and
- “knowledgeable employees” of private funds.
- Expands list of entities that qualify as an “accredited investor” to include, among others, investment advisers registered under the Investment Advisers Act of 1940 (the “Advisers Act”), and advisers registered under state law, as well as exempt reporting advisers.
- Expands list of entities that qualify as a “qualified institutional buyer” to include, among others, limited liability companies (“LLCs”) and rural business investment companies (“RBICs”).
- These amendments do not impact the financial thresholds associated with each definition for AI or QIB.
The Amendments have long been in the works and reflect significant industry input received by the SEC over a number of years. The SEC initially solicited comments on potential changes to the AI definition in 2007. In December 2015, the SEC staff published a report examining the background and history of the accredited investor definition, and in that report recommended amendments to the definition. In June 2019, the SEC published a concept release regarding the harmonization of the exempt offering framework. In addition, various other SEC advisory committees and forums adopted recommendations to changes to the AI definition during 2019. After finally proposing the new definitions in December 2019, the SEC received more than 200 unique comment letters.
Prior to the adoption of the Amendments, investors had to meet certain asset- or income-based tests in order to qualify as accredited investors. However, with the adoption of the Amendments, the SEC has created new means of qualifying as an accredited investor by adding the following categories:
- Professional Certifications. The Amendments authorize the SEC to designate by order individuals who are accredited investors because they hold qualifying professional certifications, designations and other credentials issued by a self-regulatory organization or other industry body (“Professional Certifications”), who are in good standing with respect to such Professional Certifications – regardless of their personal net worth or annual income. The Amendments include a nonexclusive list of attributes that the SEC will consider in determining which Professional Certifications qualify a natural person for accredited investor status. Although one must be in good standing in respect of its Professional Certification, the SEC did not adopt a requirement that the individual must practice in the fields related to the Professional Certification, except to the extent required by such Professional Certification itself.
- In a separate order related to the Amendment, the SEC confirmed that good standing possession of a Series 7 (General Securities Representative license), a Series 82 (Private Securities Offerings Representative license) and/or a Series 65 (Licensed Investment Adviser Representative license) is sufficient to qualify an individual as an AI.
- Knowledgeable Employees. The Amendments will enable “knowledgeable employees” of a private fund (or its investment manager) to qualify as accredited investors. “[K]nowledgeable employees” is defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940, as amended (the “Investment Company Act”), and includes, among others, (i) an executive officer, director, general partner, trustee and advisory board member, or persons serving in a similar capacity, of a private investment fund or an affiliated person of the fund that oversees the fund’s investments, and (ii) employees or affiliated persons of the private fund (excluding employees who perform solely clerical, secretarial or administrative functions) who, in connection with their regular functions or duties, have participated in the investment activities of such private fund or its affiliated adviser for at least 12 months.
- This new category of accredited investor is similar to that established by Rule 501(a)(4), which includes directors, executive officers or general partners of an issuer (or directors, executive officers or general partners of a general partner of the issuer). Rule 501(a)(4) will continue to apply both to non-fund and fund issuers.
- The SEC acknowledged that the new category of knowledgeable employees in the definition of accredited investor may overlap with the existing category in Rule 501(a)(4). However, the SEC noted that the new category of knowledgeable employees does not limit AI status to only those knowledgeable employees making investments in the private fund that they manage or co-manage (although they are limited to vehicles managed by the affiliated investment manager or its affiliates).
- Joint Salary/Net Worth Tests. The Amendments expand the term “spouse” used in the accredited investors’ salary and net worth standard to also include “spousal equivalents” (a cohabitant occupying a relationship generally equivalent to that of a spouse).
In addition, the following entities now qualify as “accredited investors”:
- Certain Family Offices and Family Clients. A “family office”, as defined under the “family office rule” under the Advisers Act, if (i) such family office has at least $5 million in assets under management, (ii) such family office is not formed for the specific purpose of acquiring the securities offered, and (iii) the 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, including any “family clients” (as defined in the family office rule) of a family office that meets the requirements stated above, whose prospective investment in the issuer is directed by such family office.
- Limited Liability Companies. The Amendment expanded the list of entities enumerated in Rule 501(c)(3) that have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered to include LLCs. This part of the Amendment codifies SEC staff’s previous guidance that LLCs may qualify as “accredited investors”.1
- Registered Investment Advisers. Investment advisers registered under Section 203 of the Advisers Act, registered under the laws of the various states or exempt from registration under Section 203(m) or 203(l) of the Advisers Act (i.e., “exempt reporting advisers”).
- Rural Business Investment Companies. RBICs (as defined in section 384A of the Consolidated Farm and Rural Development Act).
- Other Entities Meeting an Investments-Owned Test. Any entity that holds “investments” (as such term is defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered. (The SEC noted that “the intent of this new category is to capture all entity types not already included in the definition of accredited investor as well as those entity types that may be created in the future”.)
Conforming Changes in 144A
Rule 144A under the Securities Act permits a private resale of certain restricted securities to QIBs without requiring registration. The amendments allow for limited liability companies, RBICs and any institutional investors included in the AI definition that would not otherwise qualify as QIBs under Rule 144A to instead automatically qualify as such once they meet Rule 144A’s $100 million owned and invested test.
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Issuers, like private funds, making private securities offerings, or investors in any such offerings, should promptly contact their advisers to determine how the Amendments will impact their business and/or investment activity.
1 See Division of Corporation Finance interpretive letter to Wolf, Block, Schorr, and Solis-Cohen (Dec. 11, 1996).