On August 26, the Securities and Exchange Commission adopted amendments to the definitions of “accredited investor” in Rule 501(a) and “qualified institutional buyer” in Rule 144A under the Securities Act of 1933 (Securities Act). The amendments expand the definition of accredited investor, a principal test to determine eligibility for participation in private capital markets, even if they do not meet specified income and net worth tests. Amendments to the qualified institutional buyer definition similarly expand the list of eligible entities under that definition. The amendments were adopted generally as proposed with no significant changes. The proposed amendments were previously covered in the December 20, 2019 edition of the Corporate & Financial Weekly Digest.
The amended accredited investor definition in Rule 501(a):
- adds a new category to permit qualification of natural persons based on certain professional certifications, designations or credentials issued by an accredited educational institution, as designated by the SEC from time to time;
- adds, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of that fund;
- adds SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the enumerated list of entities that may qualify as accredited investors;
- consistent with existing SEC guidance, explicitly states that limited liability companies with $5 million in assets are included in the enumerated list of entities that may qualify as accredited investors;
- adds a new category to include any entity, including Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries, that (1) owns “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act of 1940 (ICA), in excess of $5 million; and (2) was not formed for the specific purpose of investing in the securities being offered;
- adds “family offices” with at least $5 million in assets under management and their “family clients,” each defined under the Investment Advisers Act of 1940 (Advisers Act); and
- adds the term “spousal equivalent,” so that spousal equivalents may pool finances for purpose of passing the qualifying income or net worth tests.
The amended qualified institutional buyer definition in Rule 144A:
- adds limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition; and
- adds 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.
Amendments to the Accredited Investor Definition
The SEC notes these amendments were prompted by the increased significance of exempt securities markets, both in terms of absolute amounts raised and relative to amounts raised in public securities markets. Prior to the adoption of these amendments, the accredited investor definition focused only on an individual’s level of wealth (income or net worth) as a proxy for financial sophistication. However, the SEC stated that relying solely on financial thresholds is suboptimal, since it may restrict access to investment opportunities for individuals whose knowledge and experience makes them capable of evaluating merits and risks of prospective investments. Therefore, the amendments create new categories of individuals and entities that qualify as accredited investors irrespective of wealth, on the basis that such investors have demonstrated the ability (through professional credentials, experience and business purpose) to appropriately assess investment opportunities, allocate capital based on their individual circumstances and otherwise make informed decisions regarding their financial interests, including their ability to bear the financial risk.
Moreover, the SEC stated it did not believe it necessary or appropriate to modify the financial thresholds set forth in the definition at this time because (1) at an individual level, removing investors from the current pool, particularly those who participated or are currently participating, in the private placement market would be inappropriate based on the imposition of costs and principles of fairness generally; and (2) at a general level, a significant reduction in the accredited investor pool through an increase in financial thresholds could have disruptive effects on the Regulation D market as a result of higher cost of capital for certain companies, particularly those in regions with lower wages, net worth or venture capital activity (thereby relying on “angel” or other individual investors). The SEC established the $200,000 individual income and $1 million net worth threshold in 1982 and the $300,000 joint income threshold in 1988 and has not updated them since. As a result, the number of US households that qualify as accredited investors has grown from approximately 2 percent of the population of US households in 1983 to 13 percent in 2019 as a result of inflation.
A. Professional Certifications, Designations and Other Credentials
The SEC stated it believes that certain professional certifications and designations or other credentials provide a reliable indication that an investor has a sufficient level of financial sophistication to participate in investment opportunities that do not have the additional protections provided by registration under the Securities Act. As a result, the amendments allow the SEC to designate qualifying professional certifications, designations and other credentials by order and include a nonexclusive list of attributes that the SEC will consider in determining which professional certifications and designations or other credentials qualify a natural person for accredited investor status. In connection with the adoption of this amendment, the SEC designated the General Securities Representative license (Series 7), the Private Securities Offerings Representative license (Series 82) and the Licensed Investment Adviser Representative (Series 65) as the initial certifications, designations or credentials under Rule 501(a)(10). Pursuant to the amendments, the SEC has the ability to reevaluate previously designated certifications, designations or credentials and designate others that are developed or are identified if consistent with specified criteria it determines are appropriate.
B. Knowledgeable Employees
The SEC added a category to enable “knowledgeable employees” (as defined in Rule 3c-5(a)(4) under the ICA) of a private fund to qualify as accredited investors for investments in the fund due to their position with the fund (and thereby their presumed meaningful investing experience and access to information necessary to make an informed investment decision about the fund’s offerings). “Knowledgeable employees” include, among other persons, trustees and advisory board members, or persons serving in a similar capacity, of a Section 3(c)(1) or 3(c)(7) fund or an affiliated person of the fund that oversees the fund’s investments, as well as employees of the private fund or the affiliated person of the fund (other than employees performing solely clerical, secretarial, or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund for at least 12 months.
C. Additional Entities
The amendment adds the following categories of entities to the enumerated list of entities that qualify as accredited investors pursuant to its definition: SEC- and state-registered investment advisers, rural business investment companies, limited liability companies, and a catch all category consisting of other entities owning a minimum threshold of investments.
In the adopting release, the SEC noted that registered investment advisers are generally considered to be institutional investors under state law, and there is no compelling reason to distinguish between SEC- and state-registered investment advisers acting for their own account from other institutional investors already treated as accredited investors. Similarly, the SEC stated that exempt reporting advisers, as advisers to private funds, also have the requisite financial sophistication needed to conduct meaningful investment analysis. Exempt reporting advisers are required under Section 203(m) or (l) of the Advisers Act to register as an investment adviser with the SEc and thereby meet the minimum asset thresholds triggering such requirement. Additionally, private funds themselves are institutional investors and all investors therein are presumed to be financially sophisticated. RBICs have a purpose similar to that of small business investment companies (SBICs), and as such, their advisers are treated similarly under the Advisers Act. SBICs are already accredited investors under Rule 501(a)(1) and, as a result of the aforementioned similarities, the amended definition now includes RBICs as accredited investors under Rule 501(a)(1). The amendment also clarifies the SEC’s longstanding staff position that limited liability companies satisfying the other requirements of the definition are eligible to qualify as accredited investors under Rule 501(a)(3). Lastly, a new category was added for any entity owning “investments” (as defined in Rule 2a51-1(b) under the ICA) in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered. The SEC’s intent was to capture all existing entity forms not already included within Rule 501(a), such as Indian tribes, labor unions, governmental bodies and funds, and entities organized under the laws of a foreign country, as well as those entity types that may be created in the future.
D. Family Offices and Family Clients
The SEC added a new category for certain “family offices” and “family clients of family offices” (each as defined under the Advisers Act). The amendments encompass a family office, and family clients of such family office, that meets the following additional requirements: (1) it has at least $5 million in assets under management; (2) it is not formed for the specific purpose of acquiring the securities offered; and (3) 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.
E. Spousal Equivalents
The amendments further allow natural persons to include spousal equivalents when calculating joint income under Rule 501(a)(6) and net worth under Rule 501(a)(5). As previously used by the SEC under the Advisers Act and in Regulation Crowdfunding, spousal equivalent is defined as a cohabitant in a relationship generally equivalent to that of a spouse.
Amendments to the Qualified Institutional Buyer Definition
Amendments to the definition of qualified institutional buyer expand the list of entities eligible for such status (such as limited liability companies, RBICs and other institutional investors included in the accredited investor definition) in order to avoid inconsistencies between the entity types eligible for accredited investor and qualified institutional buyer status, so long as any such entity meets the qualified institutional buyer requirement of owning or investing on a discretionary basis at least $100 million in securities of issuers not affiliated with such a qualified institutional buyer.
The amendments and order will become effective 60 days after publication in the Federal Register.
The SEC’s final rule is available here.
The SEC’s press release is available here.