The Securities and Exchange Commission (SEC) has officially expanded the definition of an accredited investor. The amended definition expands the pool of investors that companies can target when seeking to raise capital via private placements.
“Today’s amendments are the product of years of effort by the Commission and its staff to consider and analyze approaches to revising the accredited investor definition,” said SEC Chairman Jay Clayton in a press statement. “For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations, that may qualify to participate in certain private offerings.”
Evolution of Accredited Investor Definition
The accredited investor standard is relevant to both businesses and investors because it sets the bar for which investors can make an informed investment decision and protect their own interests in the absence of the protections of the Securities Act of 1933. Given the level of risk, federal and state securities regulations restrict many private securities offerings to accredited investors. For instance, issuers interested in raising capital from accredited investors under Regulation D must have a reasonable belief that those investors are accredited investors. In addition, issuers conducting offerings under Rule 506(c) are required to take reasonable steps to verify the accredited investor status of all purchasers in the offering.
The definition of accredited investor had not been amended since 1982 when it was enacted as part of Regulation D. Previously, an individual’s wealth was exclusively used to determine his or her level of financial sophistication. A natural person qualifies as an accredited investor if he or she has individual net worth – or joint net worth with a spouse – that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person. Alternatively, an investor satisfies the threshold if he or she has income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
The Dodd-Frank Wall Street Reform and Consumer Protection Act directed the SEC to review the accredited investor definition, citing that the current financial thresholds fail to account for decades of inflation. While there is a general consensus that changes are needed, the SEC has proceeded slowly. In 2015, the SEC issued a staff report on the accredited investor definition and several potential revisions. Most recently, in June 2019, the SEC issued a concept release that requested comments on possible approaches to amending the accredited investor definition. On December 19, 2019, the SEC formally proposed amendments to 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.
Expanded Accredited Investor Definition
The amendments adopted by the SEC on August 26, 2020, add several new categories of entities to the definition of accredited investor. As set forth in the Final Rule, the amendments to the accredited investor definition in Rule 501(a):
- Add 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 Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. According to the SEC, this approach “provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future.” Members of the public will also be able to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
- Include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- Clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- Add 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;
- Add “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
- Add 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.
The amendments to the qualified institutional buyer definition in Rule 144A add limited liability companies and RBICs to the types of entities that are eligible for qualified institutional buyer status if they meet the $100 million in securities owned and investment threshold in the definition. Additionally, the Final Rule creates a new “catch-all” category that would permit institutional accredited investors under Rule 501(a), of an entity type not already included in the qualified institutional buyer definition, to qualify as qualified institutional buyers when they satisfy the $100 million threshold.
The amendments and order will become effective 60 days after publication in the Federal Register. While the recent expansion is relatively modest, additional changes are possible. The SEC has left the door open to future changes to the accredited investor definition.
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If you have any questions or if you would like to discuss these issues further,
please contact Dan Brecher or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.