SEC Approves Amendments to Definition of Accredited Investor
On August 26, 2020, the Securities and Exchange Commission (“SEC”) approved amendments to the U.S. Securities Act of 1933, as amended (the “Securities Act”), which, among other things, expand the definition of accredited investor (the “Amendments”). The Amendments are significant as only offers and sales of securities to accredited investors benefit from key exemptions from the registration requirements of the Securities Act, including certain private placements of securities made pursuant to Regulation D. The Amendments will become effective on December 8, 2020.
The SEC made several meaningful changes to the definition of accredited investor. First, the Amendments broaden the definition to include persons possessing qualifying professional certifications, designations or other credentials or persons qualifying as “knowledgeable employees” of private funds. Furthermore, the Amendments allow investors to satisfy the definition of accredited investor by aggregating their net worth and income with spousal equivalents. Finally, the Amendments capture previously excluded types of legal entities under the definition of accredited investor, as well as “family funds.”
Professional Certifications, Designations or Other Credentials
Prior to the Amendments becoming effective, an investor’s annual income or net worth, in the case of a natural person, or the value of an investor’s assets, in the case of a legal entity, will generally determine whether such person or entity qualifies as an accredited investor. However, commentators have long remarked that such financial thresholds may exclude investors who, by virtue of their education, qualifications or professional experience, possess sufficient sophistication to participate in private capital markets without needing the protections of the Securities Act.
The Amendments address these concerns by broadening the definition of accredited investor to include other, more qualitative tools for assessing investor sophistication. Most significantly, the definition will now include natural persons holding in good standing one or more professional certifications, designations or other credentials as the SEC may designate from time to time. Initial certifications and designations recognized by the SEC as satisfying the definition of accredited investor include:
- Licensed General Securities Representative (Series 7);
- Licensed Investment Adviser Representative (Series 65); and
- Licensed Private Securities Offerings Representative (Series 82),
each as administered by the Financial Industry Regulatory Authority, Inc. Accredited educational institutions, self-regulatory organizations or other industry bodies may apply to the SEC for consideration as a qualifying professional certification, designation or credential and members of the public may likewise propose inclusion of specific degrees or programs of study.
In addition to capturing natural persons with qualifying professional certifications, designations or other credentials under the definition of accredited investor, the Amendments also create a new category of accredited investor: "knowledgeable employees". In doing so, the Amendments enable private fund employees who participate in the fund’s investment activities or hold a qualifying position (meaning an executive officer, director, trustee, general partner, advisory board member or similar position) to also invest in the fund’s securities, despite not otherwise qualifying as an accredited investor. Typically, whether a fund employee is “knowledgeable” will require a case by case examination of the employee’s role within the fund.
Relatedly, under Rule 501(a)(8) of the Securities Act, a private fund with assets of $5 million or less may qualify as an accredited investor if all of the fund's equity owners are accredited investors. The Amendments will allow these small private funds to accept investments from knowledgeable employees without jeopardizing their own status as accredited investors.
Joint Net Worth and Income Aggregation with Spousal Equivalents
Pursuant to the Amendments, the SEC expanded the concept of "joint net worth" and "joint income" for the purposes of the definition of accredited investor to permit aggregation with an investor's spouse or spousal equivalent. Formerly, the definition limited aggregation with the net worth and income only of an investor’s spouse. A spousal equivalent is eligible for aggregation where such person is a cohabitant occupying a relationship with the investor generally equivalent to that of a spouse. The Amendments also clarify that securities purchased in reliance on the joint net worth or income tests do need to be purchased jointly.
LLCs and Other Previously Excluded Legal Entities
The Amendments also revise the definition of accredited investor with respect to legal entities. Most significantly, limited liability companies, previously excluded from the definition, now qualify as accredited investors where such entities have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered. The expanded definition also includes investment advisers registered under Section 203 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”), or under similar state laws, exempt reporting advisers under Section 203 (l) or (m) of the Advisers Act and rural business investment companies.
Additionally, the amended definition of accredited investor includes a “catchall,” capturing any type of entity not otherwise covered so long as it is not formed for the specific purpose of acquiring the securities being offered. Unlike those entities explicitly referenced in the definition, these other types of entities would qualify for accredited investor treatment on the basis of investments, not total assets, in excess of $5 million.
The Amendments also include “family offices” (as defined in the SEC's Family Office Rule) with at least $5 million in assets under management and their “family clients” under the definition of accredited investor. To qualify, the prospective investment must be 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 such investment. In addition, the family office cannot have been formed for the specific purpose of acquiring the securities offered.
While significant, the Amendments demonstrate the SEC’s determination to balance its sometimes competing objectives to promote capital formation and maintain robust investor protections, resulting in cautious improvement and simplification of the exemptions available to issuers from the registration requirements of the Securities Act. As a result, the impact of the Amendments on capital markets will likely be modest. Nonetheless, the Amendments introduce new opportunities for sophisticated investors and for legal entities previously excluded from certain exempt offerings.
In the coming months, issuers, funds and their counsel should review their offering documentation, including investor questionnaires, investor “click throughs” and subscription agreement offering restrictions, to reflect the Amendments.