On Aug. 26, 2020, the Securities and Exchange Commission (SEC) announced amendments to the definitions of “accredited investor” and “qualified institutional buyer” (QIBs) to expand the universe of investors who are eligible to participate in certain common types of private securities offerings (available here). The amendment is effective 60 days after publication in the Federal Register.
Background
The amendments are part of the SEC’s ongoing effort to simplify, harmonize and improve the exempt offering framework under the Securities Act to promote capital formation and expand investment opportunities while maintaining appropriate investor protections.
These definitions are important in securities transactions exempt from the registration requirements of the Securities Act of 1933 in determining investor eligibility. In the adopting release, the SEC noted that in 2019, “registered offerings accounted for $1.2 trillion (30.8 percent) of new capital, compared to approximately $2.7 trillion (69.2 percent) . . . through exempt offerings.” Of this, an estimated $1.56 trillion was raised in offerings under Rule 506 of Regulation D under the Securities Act, the most common type of exempt securities offering.
The accredited investor amendments add several new categories of individual and entity investors, including individual investors who may not meet the net worth or income requirements but have sufficient knowledge and expertise to participate in exempt securities offerings. Exempt offerings typically do not have the rigorous disclosure and procedural requirements, and related investor protections, provided by registration under the Securities Act. The QIB amendments add categories of institutional investors. The amendments do not remove any of the existing categories of accredited investors or QIBs.
What To Do Next
When effective, the amended definitions will expand the universe of investors that can participate in, for example, exempt offerings under Rule 506 of Regulation D under the Securities Act. Issuers in such offerings should consider updating their offering documents to include the additional categories of permitted investors. If an offering straddles the effective date, issuers should consult with legal counsel to determine the appropriate way to handle the expansion of the universe of eligible investors.
Amendment of Accredited Investor Definition
The SEC made the following amendments to the accredited investor definition in Rule 501(a) of Regulation D:
- Natural Persons Holding Professional Certifications – Added a new Rule 501(a)(10) for individuals holding and being in good standing with certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the SEC may designate from time to time by order, after notice and opportunity for public comment. The amendment includes a nonexclusive list of attributes that the SEC will consider in making such designations. In conjunction with the adoption of the amendments, the SEC designated by order that holders in good standing of the General Securities Representative license (Series 7), the Private Securities Offerings Representative license (Series 82), and the Licensed Investment Adviser Representative (Series 65), each as issued by the Financial Regulatory Authority (FINRA), are qualifying natural persons.
- “Knowledgeable Employees” of Private Funds – Added a new Rule 501(a)(11), with respect to investments in a private fund, for natural persons who are “knowledgeable employees” (as defined in Rule 3c-5(a)(4) under the Investment Company Act) of the fund. A benefit of the amendment is that it will permit knowledgeable employees who would not otherwise qualify as accredited investors to invest in a small fund without jeopardizing the fund’s status as an accredited investor under Rule 508(a)(8) of Regulation D, which requires all equity owners to be accredited investors. In the adopting release, the SEC noted that Rule 501(a)(11) does not limit accredited investor status to only those knowledgeable employees making investments in the private fund of which they participate in the management because many employees of managing entities are likely included in the knowledgeable employee definition through the concept of “affiliated management persons” (as defined by Rule 3c-5 under the Investment Company Act) and existing language in the knowledgeable employee definition that includes persons who in connection with their regular functions or duties, participate in the investment activities of the fund, or other funds or investment companies the investment activities of which are managed by affiliated management persons of the fund. The SEC also stated that the accredited investor status of a knowledgeable employee can be attributed to his or her spouse with respect to joint investment in a private fund (but did not extend it to spousal equivalents).
- Limited Liability Companies – Added limited liability companies in Rule 501(a)(3) to codify the long-standing SEC staff position that limited liability companies with $5 million in assets not formed for the specific purpose of acquiring the securities being offered qualify as accredited investors. In the adopting release, the SEC noted that managers (whether member managers or third-party managers) of limited liability companies perform a policymaking function for the issuer equivalent to that of an executive officer of a corporation under Rule 501(f) and, therefore, declined to add limited liability company managers to Rule 501(a)(4) or Rule 501(f).
- Investment Advisers – Added SEC- and state-registered investment advisers as well as federally exempt reporting advisers to Rule 501(a)(1).
- Rural Business Investment Companies (RBICs) – Added RBICs to Rule 501(a)(1).
- Catch-All for Other Entities – Added a new Rule 501(a)(9) to capture all entity types (whether currently existing or that may be created in the future) not listed in any of the other accredited investor categories in Rule 501(a) that own “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered. In the adopting release, the SEC noted that the amendment is broad enough to cover Indian tribes and the divisions and instrumentalities thereof, federal, state, territorial and local government bodies, certain funds not otherwise covered, and entities organized or under the laws of foreign countries. The SEC also noted that it believed an investment test rather than an asset-based test is a more reliable indicator of whether an entity is likely to require the protections of Securities Act registration.
- Family Offices – Added a new Rule 501(a)(12) for “family offices” (as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940) (i) with at least $5 million in assets under management, (ii) not formed for the specific purpose of acquiring the securities offered, and (iii) where 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 – Added a new Rule 501(a)(13) for “family clients” (as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act or 1940) of family offices whose prospective investment in the issuer is directed by such family office.
- Spousal Equivalent – Added the concept of “spousal equivalent” to the net worth standard in Rule 501(a)(5) (individual or joint net worth of $1 million) and the income standard in Rule 501(a)(6) (individual income in excess of $200,000 or joint income in excess of $300,000) and an associated definition in new Rule 501(j), allowing spousal equivalents to pool their finances for the purpose of qualifying as accredited investors. The term “spousal equivalent” means “cohabitant occupying a relationship generally equivalent to that of a spouse,” based on existing definitions found in the Investment Advisers Act and Regulation CF.
- New Note Regarding Joint Net Worth – Added a note to codify an existing SEC staff position that the calculation of “joint net worth” for purposes of Rule 501(a)(5) can be the aggregate net worth of an investor and his or her spouse or spousal equivalent (regardless of whether property is owned jointly), and that the securities being purchased by an investor relying on the joint net worth test of Rule 501(a)(5) need not be purchased jointly.
- Look Through to Accredited Investors under Rule 501(a)(8) – Added a note to codify an existing SEC staff position that, in determining accredited investor status under Rule 501(a)(8), one may look through various forms of equity ownership to natural persons. The purpose of the amendment is to clarify that it is appropriate to look through various forms of ownership under Rule 501(a)(8) to natural persons in those cases where an equity owner of an entity is itself an entity, but that owner-entity does not qualify on its own merits as an accredited investor.
In addition, the SEC amended Securities Act Rule 215 by replacing the existing definition with a cross reference to the definition in Securities Act Rule 501(a), and made conforming amendments to Rule 163B under the Securities Act (regarding test-the-waters communications) and to Exchange Act Rule 15g-1 (exempting certain “penny stock” transactions from broker-dealer disclosure requirement).
In the adopting release, the SEC also noted that it declined to adopt amendments to (i) modify the financial thresholds in Rule 501(a) for inflation at this time, noting that it will continuously monitor the thresholds in its review of the accredited investor definition required by the Dodd-Frank Act, (ii) provide for geography-specific financial thresholds to account for income and wealth disparities, noting that doing so would create complexities, and (iii) include investors advised by a registered investment adviser or a registered broker-dealer as accredited investors, noting that recommendation by a broker-dealer and advice by a registered investment adviser should not serve as a proxy for an investor’s financial sophistication or his or her ability to sustain the risk of loss of investment or ability to fend for him or herself.
Amendment of QIB Definition
The SEC also made similar amendments to expand the definition of qualified institutional buyer in Securities Act Rule 144A to include RBICs (Rule 144A(a)(1)(i)(C)), limited liability companies (Rule 144A(a)(1)(i)(H)) and any institutional investors included in the accredited investor definition in Securities Act Rule 501(a) that are not otherwise enumerated in the definition of qualified institutional buyer (Rule 144A(a)(1)(i)(J)), in each case, provided they satisfy the $100 million threshold. In addition, the SEC added a note to clarify that an entity seeking qualified intuitional buyer status under Rule 144A(a)(1)(i)(J) may be formed for the purpose of acquiring the 144A securities being offered.
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