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SEC Expands Definition of Accredited Investor

On August 26, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments expanding the definition of an accredited investor. This has enlarged the potential pool of investors by adding new categories of investors eligible to participate in unregistered private offerings under Regulation D (Reg D) of the Securities Act of 1933 (the Act).[1] In addition, this new definition adds several new categories of entities that now qualify as accredited investors. In adopting the amendments, the SEC has taken a step towards harmonizing its regulatory framework with current technology and evolving market practices by “updat[ing] and improv[ing] the accredited investor definition to identify more effectively institutional and individual investors that have the knowledge and expertise to participate in private capital markets.”[2] The Amendments will become effective 60 days after they are published in the Federal Register.

New Categories of Accredited Investors

The amendments create several new categories of potential investors under the “accredited investor” definition.

  • Professional Persons. A new category that allows natural persons to qualify as accredited investors based on certain professional certifications and credentials. The SEC has designated that holders in good standing of the Series 7 (licensed general securities representative), Series 65 (licensed investment adviser representative), and Series 82 (licensed private securities offerings representative) licenses are qualifying natural persons for purposes of the definition.
     
  • Limited Liability Companies.The SEC has officially codified that limited liability companies not formed for the specific purpose of investing in the securities being offered, with total assets in excess of $5 million, qualify as accredited investors.[3]
     
  • Look-Through Policy. The revised definition also includes any entity (e.g., a limited liability company) in which all of its equity holders are an accredited investor, regardless of whether or not the entity by itself meets the definition. Therefore, where a potential purchaser is owned by an entity that by itself does not qualify, the issuer may “look-through” the entity and instead to its natural person equity owners to determine whether they each independently qualify as an accredited investor.[4]
     
  • Knowledgeable Persons. Natural persons are also included as accredited investors where they are making investments in a private fund and such natural persons are knowledgeable employees of the private fund.[5]
     
  • Certain Registered Advisers.SEC and state-registered investment advisers, exempt reporting advisers, and rural business investment companies have been added to the list of entities that may qualify, without regard to any requirement for a minimum level of total assets.
     
  • Family Offices. Also added to the definition are “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 of 1940, as amended.[6]
     
  • Spousal Equivalent. The term “spousal equivalent” has also been added to the definition so that spousal equivalents may pool their finances to satisfy the income and net worth tests of the accredited investor definition. The term spousal equivalent is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.
     
  • Catch-all Category. Also added is a new “catch-all” category for any entity that owns investments[7] exceeding $5 million and that was not formed for the specific purpose of investing in the securities offered.[8]

Background to the Amendments to Accredited Investor

Reg D is a non-exclusive “safe harbor” for the private (unregistered) offering of securities.[9] Unless an exemption from registration can be found under the federal securities laws (e.g., the safe harbor in Reg D), offers and sales of securities must be registered with the SEC under the Act. Registration of a securities offering is an expensive and time-consuming process, particularly for private companies (e.g., companies that have not already conducted a registered initial public offering or are not otherwise already required to file reports with the SEC). As a result, most securities offerings are conducted as private offerings through exemptions from registration under the Act.[10]

It is important to note that the purpose of the Act’s registration requirements for the offer and sale of securities is to provide adequate and meaningful disclosure to prospective investors. Before making an investment decision, investors should be informed of all material aspects of an issuer’s business including the management, financial condition, workforce dependency, key employees, and risks of the investment. This disclosure provides prospective investors with a reasonably informed basis to make an investment decision regarding the issuer’s securities being offered.

Investors in unregistered offerings can be subject to investment risks not associated with registered offerings, because some securities law liability provisions do not apply to private offerings.[11] Issuers of unregistered securities generally are not required to provide information comparable to the information that is required in a registration statement, and the SEC does not receive or review any information that may be provided to investors in these offerings (e.g., a private placement memorandum or PPM).[12]

Practical Considerations of the Amendments

There are several practical considerations that may be noteworthy in anticipation of the amendment's effectiveness.

  • Unchanged Financial Threshold. The amendments did not increase the financial qualifying threshold that certain persons must exceed in the accredited investor definition. That threshold amount ($5 million in total assets) remains unchanged.
     
  • Certification Document Updates. Issuers (e.g., private equity and venture capital funds and other capital raising market participants) should carefully review their current subscription documents and/or certification documentation in order to update and harmonize them with the changes that have been made to the accredited investor definition.[13]

The amendments may signal a first step in a larger movement towards broadening the potential investor pool for issuers including private equity and venture capital firms as well as other potential capital raising market participants.

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This memorandum is a summary of the topics discussed above and does not purport to provide legal advice. No legal or business action should be based upon the above summary. 


[1] See “Amending the “Accredited Investor” Definition” Release Nos. 33-10824; 34-89669 (Aug. 26, 2020). See the full text of the adopting release at: https://www.sec.gov/rules/final/2020/33-10824.pdf

[2] In a recent SEC conceptual release, the SEC set forth its effort to consider ways to simplify, harmonize, and improve the exempt offering framework under the Act. See Release No. 33-10649 (June 18, 2019) (seeking public comment on “ways to simplify, harmonize, and improve the exempt offering framework to promote capital formation and expand investment opportunities while maintaining appropriate investor protections”). See the full text of this conceptual release at: https://www.sec.gov/rules/concept/2019/33-10649.pdf

[3] In the past, limited liability companies have been permitted to be considered accredited investors by virtue of SEC Staff interpretive advice. The amendments now formally recognize by rule this long-standing SEC Staff position.

[4] The amendments include a note to the accredited investor definition that codifies this SEC Staff interpretation.

[5] A knowledgeable employee is generally defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940, as amended (40 Act) to include an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the private fund.

[6] Family offices are generally defined under 275.202(a)(11)(G)-1 of the Advisers Act as private advisory entities established by families to manage their assets, plan for their families’ financial future, provide other services to family members, and who do not hold themselves out to the public as investment advisers.

[7] See Rule 2a51-1(b) under the 40 Act, generally defining such investments as investments in independently controlled companies meeting certain minimum requirements and held for investment purposes.

[8] The amendments list, as non-exclusive examples, additional entities covered by this clause. These include Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries.

[9] Pursuant to Section 4(a)2 of the Act, securities transactions by an issuer not involving any public offering are exempt from the registration requirements of the Act. Pursuant to the Reg D safe harbor, an issuer may offer and sell an unlimited amount of securities so long as those offers and sales are made without the use of general solicitation or general advertising and the sales are made only to accredited investors and up to 35 non-accredited investors who meet a sophistication requirement. In addition, the issuer must first furnish to the non-accredited investors certain material supplemental information that may be necessary in order for such non-accredited investors to make an informed investment decision.

[10] According to the adopting release, in 2019, registered offerings accounted for $1.2 trillion (30.8%) of new capital raises, while exempt offerings accounted for approximately $2.7 trillion (69.2%). The estimated amount of capital reported as being raised in offerings under Rule 506(b) and 506(c) of Reg D was approximately $1.56 trillion, or more than half of the total exempt offerings in 2019.

[11] For example, there are no specific requirements to provide certain required rule based information (such as, specific financial statements, material legal proceedings disclosure, board and executive management experience or the delivery of a “prospectus”). It is also important to note, however, that all securities transactions, even exempt transactions, remain subject to the antifraud provisions of the federal securities laws. This means that issuers are responsible for false or misleading statements that it or others acting on its behalf make regarding the issuer, the securities offered, or the private offering. The issuer is responsible for any such statements, whether made by it or others acting on its behalf, and regardless of whether they are made orally or in writing.

[12] Therefore, the SEC places great emphasis on the protection of investors when evaluating the adoption or amendment of an exemption from the protections of registration. Being able to qualify as an accredited investor is significant, because accredited investors may participate in investment opportunities that may not otherwise be available to non-accredited investors.

[13] For example, some of the new accredited investor categories are based upon easily verifiable criteria (such as whether an investor holds a valid Series 7, 65 or 82 license). This could widen the door for certain private funds in their capital raising efforts, because by relying on Rule 506(c), a private fund can more easily verify the accredited investor status of potential investors that will fall within these new categories. However, issuers relying on Rule 506(c) of Reg D remain under the blanket responsibility to take reasonable steps in verifying the accredited investor status of each purchaser of the securities sold in the offering.

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