On August 26, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments that expand the definition of “accredited investor” under the Securities Act of 1933, as amended (the Securities Act). These amendments are designed to modernize the definition of “accredited investor” and, among other things, open private offers under Regulation D to a wider group of sophisticated investors.
Changes to Regulation D, Rule 501(a)
Individuals: Previously, individuals had to have a net worth of at least $1 million excluding the value of their primary residence, or income of at least $USD 200,000 ($300,000 for couples). The adopted changes now allow individuals to qualify based on their credentials which include professional knowledge, certain certification or the individual’s relationship with the issuer. Now included as accredited investors are the following (regardless of income or assets):
- Certifications: Anyone with a Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65) and Licensed Private Securities Offerings Representative (Series 82). The SEC has the authority to periodically add categories to this list.
- Knowledgeable Employees: Anyone who is a “knowledgeable employee” of a private fund. For a definition of this term, the SEC reached through to the Investment Company Act of 1940 (ICA). Employees of private funds will qualify of they are:
- an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity of the private fund or an affiliated management person of the private fund; or
- an employ of the private fund or an affiliated management person of the private fund (other than an employee performing solely clerical, secretarial or administrative functions with regard to the fund or its investments) who, in connection with his or her regular functions or duties, participates in the investment activities of the private fund, other private funds, or investment companies the investment activities of which are managed by such affiliated management person of the private fund, so long as this person has been doing this for at least 12 months.
- Spousal Equivalents: Joint income and assets may be included from Spousal Equivalents when calculating qualification under the accredited investor financial tests described above. The SEC views a Spousal Equivalent as a cohabitant occupying a relationship generally equivalent to that of a spouse.
Entities: With this amendment the SEC adjusts the accredited investor definition to add several categories of entities:
- Registered Investment Advisers: As adjusted, the adviser must be registered at either the state or federal level to qualify. Exempt reporting advisers are considered “registered” for purposes of this rule.
- Rural Business Investment Companies: Companies who are approved by the U.S. Secretary of Agriculture and have entered into a participation agreement with the Secretary are considered Rural Business Investment Companies and, under the amendment, are accredited investors.
- Limited Liability Companies: Regulation D Rule 501(a)(3) allows partnerships, Internal Revenue Code Section 501(c)(3) organizations, Massachusetts or similar business trusts and corporations to qualify for accredited investor status if they have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered. The amendment adds limited liability companies to this list.
- Foreign and Other Entities: Indian Tribes, labor unions, governmental bodies and funds, and entities organized under the laws of a non-U.S. jurisdiction have not been previously addressed as accredited investors. To remedy this the SEC has adjusted the definition to include entities that own “investments” in excess of USD $5 million, which is not formed for the purpose of acquiring the securities being offered. Again, the SEC is pulling a definition from the ICA, so in this context “Investments” will include real estate, commodity interests, physical commodities, and non-security financial contracts held for investment purposes, cash and cash equivalents.
- Family Offices and Family Clients: Family Offices are entities established by families to manage their assets, plan for their families’ financial future, and provide other services to family members. Family Clients generally are family members, former family members, and certain key employees of the family office, as well as certain of their charitable organizations trusts, and other types of entities. Both of these definitions largely mirror their counterparts in the Investment Advisers Act of 1940. For a Family Office to qualify as an accredited investor it must (i) have at least $5 million in assets under management (ii) not be formed for the specific purpose of acquiring the securities offered, and (iii) be directed by a person who has such knowledge and experience in financial and business matters that the Family Office would be capable of evaluating the merits and risks of the prospective investment. Family Clients of a Family Office that meets the requirements above are also considered to be accredited investors.
- Qualification Through Owner Status: Under Regulation D Rule 501(a)(8) an entity can qualify as an accredited investor so long as all of the owners are accredited investors. In some cases the entity seeking to be an accredited investor is owned by another entity. The SEC has added language clarifying that for purposes of this test all of the entities in the chain may be looked through to the ultimate owners to determine accredited investor status.
Changes to Rule 215
The SEC also adopted amendment to the existing definition in Rule 215 to provide a cross reference to the accredited investor definition in Rule 501(a).
- Rule 215 defines the term “accredited investor” under Section 2(a)(15) of the Securities Act for purposes of Section 4(a)(5) of the Securities Act, which provides an exemption for issuers for the offer and sale of securities to accredited investors if the aggregate offering amount does not exceed $5 million; the issuer, or anyone acting on its behalf, does not engage in general solicitation or general advertising; and the issuer files a notice on Form D with the SEC.
- The accredited investor definition in Rule 215 has historically been substantially consistent but not identical to the accredited investor definition in Rule 501(a) of Regulation D. For example, in contrast to the definition in Rule 501(a), the scope of the accredited investor definition in Rule 215 does not include banks, insurance companies, registered investment companies, business development companies as defined in Section 2(a)(48) of the Investment Company Act, or small business investment companies. In addition, the accredited investor definition in Rule 215 does not contain a reasonable belief standard as in Rule 501(a).
- The cross-referenced definitions are intended to ensure uniformity in the accredited investor definition in both provisions.
Changes to Rule 144A
The SEC also adopted amendments to the “qualified institutional buyer” definition in Rule 144A under the Securities Act to expand the list of entities that are eligible to qualify as qualified institutional buyers.
- The definition of “qualified institutional buyer” in Rule 144A is similarly intended to “identify a class of investors that can be conclusively assumed to be sophisticated and in little need of the protection afforded by the Securities Act’s registration provisions.” With the exception of registered dealers, a qualified institutional buyer must in the aggregate own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with such a qualified institutional buyer.
- The amendments expand the list of entities eligible for qualified institutional buyer status to be consistent with the amendments to the “accredited investor” definition, maintaining the $100 million threshold for these entities to qualify for qualified institutional buyer status.
- In this way, the amendments avoid inconsistencies between the entity types eligible for each status while continuing to ensure that these entities have sufficient financial sophistication to participate in investment opportunities that do not have the additional protections provided by registration under the Securities Act.
The final rule becomes effective 60 days after publication in the Final Register. Obligations to keep records of how a private fund purchaser is considered an accredited investor have not changed as a result of this amendment. Private Funds who are offering under Regulation D should consider whether their investor questionnaires need to be updated.