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SEC Issues Amendments to Expand Accredited Investor Definition

On August 26, 2020, the Securities and Exchange Commission (“SEC”) adopted amendments to modify the definition of “accredited investor” in Rule 501(a) under the Securities Act, which is an important qualification that determines what groups of investors may purchase securities through private offerings.

These amendments will expand the number of investors eligible to participate in private offerings by adding new categories of individuals who may qualify as accredited investors based on their certifications, experience, or professional knowledge. The amendments will also expand the groups of entities that qualify as accredited investors.

New Categories of Natural Persons

The amendments will add additional categories of natural persons who would qualify as an accredited investor even if they do not meet the traditional net worth or income requirements. The new categories include persons who: (1) hold certain professional certifications, designations, or other credentials, or (2) are “knowledgeable employees” of private funds and are investing in the private fund.

Under the new Rule 501(a)(10), individual investors may qualify for accredited investors status solely on the basis of holding certain professional certifications, designations, and other credentials that are recognized by the SEC as qualifying the investors. An individual must maintain the qualifying certifications, designations, or credentials in good standing in order to qualify for accredited investor status. A list of all certifications, designations, and credentials currently recognized by the SEC as qualifying will be posted on the SEC’s website.

The SEC is also adding a category to the accredited investor definition to allow “knowledgeable employees” of private funds, as defined in Rule 3c-5(a)(4) of the Investment Company Act, to qualify as accredited investors for investments in the fund. Knowledgeable employees of a private fund generally include (i) executive officers, directors, trustees, advisory board members or persons serving in a similar capacity of the private fund or affiliated persons that oversee the fund’s investments; and (ii) employees or affiliated persons of the fund (other than employees performing solely clerical, secretarial or administrative functions) who, in connection with the employees’ regular functions, have participated in the investment activities of such private fund for at least 12 months.

Expanded List of Qualified Entities

The SEC’s definition of “accredited investor” provides an exhaustive list of entities that qualify as an accredited investor. The Commission is now expanding this list to include:

• SEC and state-registered investment advisers;
• Exempt reporting investment advisers under Section 203(l) or (m) of the Advisers Act;
• Rural business investment companies (RBICs);
• Limited liability companies (LLCs) that (1) have total assets in excess of $5 million, and (2) were not formed for the specific purpose of acquiring the securities being offered;
• Family offices and family clients, as defined in 17 CFR § 275.202(a)(11)(G)-1, with at least $5 million in assets under management. The amendments would apply only to a family office that is not formed for the specific purpose of acquiring the securities offered, and whose purchase 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 investment;
• Any other type of entity that (1) owns investments, as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million, and (2) was not formed for the specific purpose of acquiring the securities being offered.

Other Amendments

Spousal Equivalents: The SEC now allows individuals to include joint income from “spousal equivalent” when pooling finances to qualify as accredited investors under the joint net worth or income thresholds in Rules 501(a)(5) and (a)(6). “Spousal equivalents” are defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse.” Under the new amendments, the income and net worth of spousal equivalents would count even if the securities were purchased individually and not jointly.

Equity Ownership Look-through: Under Rule 501(a)(8), an entity qualifies as an accredited investor if all of its equity owners are accredited investors. Because in some cases, an equity owner of an entity is another entity, as opposed to a natural person, one may now look through multiple forms of equity ownership to natural persons to determine the accredited investor status.

The SEC also replaced the “accredited investor” definition in Securities Act Rule 215 with a cross-reference to the definition in Rule 501(a). Moreover, the SEC adopted conforming amendments to Securities Act Rule 163B, and Exchange Act Rule 15g-1.

QIBs

The amendments will also expand the qualified institutional buyer exemption under Rule 144A by adding RBICs to Rule 144A(a)(1)(i)(C) and LLCs to Rule 144(a)(1)(i)(H). In addition, the amendment creates new Rule 144A(a) (l)(i)(J) to allow entities that are accredited investors under Rule 501(a) which also qualify for QIB status when they meet the $100 million in securities owned and invested threshold.

These amendments will become effective 60 days after publication in the Federal Register.

Although these changes allow additional types of investors to qualify as accredited investors, the SEC has not chosen to change the financial levels required to qualify as accredited investors, despite much discussion over the past few years that the levels needed review and updating.

Please contact your attorney at Sherin and Lodgen if you have any questions or we can assist you in any way.