The Securities and Exchange Commission (“SEC”) has adopted amendments to update the definition of “accredited investor” in the SEC’s rules, and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act of 1933 (“Securities Act”). The proposed amendments are intended to update and improve the definitions to identify more effectively institutional and individual 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 Securities Act.
As a result, the amendments to the accredited investor definition have added new categories of qualifying natural persons and entities, and made certain other modifications to the existing definition. The amendments to the qualified institutional buyer definition similarly expand the list of eligible entities under that definition. The proposed amendments will become effective 60 days after posting in the Federal Register.
Background
The amendments are part of the SEC’s ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation. To that end, the accredited investor definition is a central component of the Rule 506 exemptions from registration and plays an important role in other exemptions and other federal and state securities law contexts. Qualifying as an accredited investor, either as an individual or an institution, is significant because accredited investors may, under SEC rules, participate in investment opportunities that are generally not available to non-accredited investors, including certain investments in private companies and offerings by certain hedge funds, private equity funds, and venture capital funds.
Historically, the Commission has stated that the accredited investor definition was “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or fend for themselves render the protections of the Securities Act’s registration process unnecessary.” Prior to the adoption of these final rules, in the case of individuals, the accredited investor definition has used wealth, in the form of a certain level of income or net worth, as a proxy for financial sophistication.
The final rules are tailored to permit investors with reliable alternative indicators of financial sophistication to participate in such investment opportunities, while maintaining the safeguards necessary for investor protection and public confidence in investing in areas of the economy that disproportionately create new jobs, foster innovation, and provide for growth opportunities. As such, while wealth is still a means to establish financial sophistication, the SEC has taken the position that it is not the sole means of making such a determination.
Rather, the characteristics of an investor contemplated by the definition can be demonstrated in a variety of ways. These include the ability to assess an investment opportunity, which includes the ability to analyze the risks and rewards, the capacity to allocate investments in such a way as to mitigate or avoid risks of unsustainable loss, or the ability to gain access to information about an issuer or about an investment opportunity, or the ability to bear the risk of a loss. Accordingly, the final rules create new categories of individuals and entities that qualify as accredited investors irrespective of their wealth, on the basis that such investors have demonstrated the requisite ability to assess an investment opportunity.
Summary of Amendments to Definition of Accredited Investor
Specifically, the amendments add new categories of natural persons that may qualify as an accredited investor based on certain professional certifications or designations or other credentials or their status as a private fund’s “knowledgeable employee,” expand the list of entities that may qualify as accredited investors, add entities owning $5 million in investments, add family offices with at least $5 million in assets under management and their family clients, and add the term “spousal equivalent” to the definition. The following summarizes the amendments to the accredited investor definition in Rule 501(a):
- Added a new category to the definition that permits natural persons to qualify as accredited investors based on 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. In conjunction with the adoption of the amendments, the SEC has specifically designated that holders in good standing of the Series 7, Series 65, and Series 82 licenses are qualifying natural persons;
- Include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- Clarified that limited liability companies with $5 million in assets, may be accredited investors, and added SEC and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- Added a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, 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;
- Added “family offices” with at least $5 million in assets under management, and their “family clients,” as each term is defined under the Investment Advisers Act; and
- Added the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents, may pool their finances for the purpose of qualifying as accredited investors.
Qualified Institutional Buyer Amendments
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 final rules expand the list of entities eligible for “qualified institutional buyer” status pursuant to Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition. The amendments also add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
In utilizing this approach, the SEC believes that the final rules 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.
Action Items
The proposed rule will become effective 60 days following publication in the Federal Reserve, which will in all likelihood occur in the 4th Quarter of 2020. As a result, broker/dealers marketing private placements, investment advisers recommending alternative investments and issuers of those private offerings will need to review and revise investor questionnaires, subscription documentation, offering documents and procedures should they elect to rely on the expanded categories set out in the revised rule for an Accredited Investor.