Key Points

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• On August 26, 2020, the Securities and Exchange Commission (SEC) adopted amendments that broaden the qualifying pool of individuals and entities known as “accredited investors.”
• The amendments expand the definition based on defined measures of professional knowledge, experience, or certifications, in addition to the existing tests for income or net worth.
• The amendments also add to the list of entities that may qualify as accredited investors, including allowing any entity that meets an investments test to qualify.

Background

Under U.S. federal securities laws, a company that offers its securities must register those securities with the SEC or find an exemption from the registration requirements. The federal securities laws provide companies with a number of exemptions. For some of the exemptions, such as Rule 506 of Regulation D, a company may sell its securities to what are known as “accredited investors.” The term “accredited investor” is defined in Rule 501 of Regulation D.

On August 26, 2020, the SEC adopted amendments expanding the definition of an “accredited investor” under the Securities Act of 1933 (the “Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”). Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, were disqualified from the opportunity to invest in U.S. private capital markets. The amendments adopted by the SEC revise the definition to more effectively identify individual and institutional investors that have the knowledge and expertise to participate in those markets. In a statement SEC Chairman Jay Clayton stated, “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.”

The amendments to the accredited investor definition add new categories of qualifying natural persons and entities and make 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.

Amendments Under the Act

The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Act.

Under Rule 501(a) of Regulation D:

• Added a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations,  credentials, or other credentials issued by an accredited educational institution as designated by the SEC. In addition, holders in good standing of the Series 7, Series 65, and Series 82 licenses are now qualified natural persons;
• 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;
• 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;
• Included as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund (i.e. certain executives or others close to the investment process at the fund or its investment adviser); and
• Clarified that limited liability companies (LLCs) with $5 million in assets may be accredited investors

Under Rule 215:

• Replaced the existing definition with a cross reference to the definition in Rule 501(a).

Under Rule 144A:

• Expanded the definition of “qualified institutional buyer” to include LLCs and RBICs if they meet the $100 million in securities owned and invested threshold in the definition; and
• Added 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.

The SEC also adopted conforming amendments to Act Rule 163B (Institutional Accredited Investors) and Exchange Act Rule 15g-1 (Institutional Accredited Investors exemptions).

What Hasn't Changed?

The net worth tests and dollar thresholds, for both natural persons and entities, under the prior definition remain intact. For example, any natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1 million is still considered an accredited investor. Similarly, any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year would still be considered an accredited investor. Likewise, subject to certain exceptions and qualifications under the Act or the Exchange Act, many entities such as banks, brokerages, insurance companies, investment companies, trusts and 501(c)(3) organizations with total assets in excess of $5million continue to qualify as accredited investors.

Balancing Between Investor Protection and Access to Capital Markets

Regulation D originated as an effort to assist small business capital formation. The original accredited investor definition was intended to encompass those individuals whose financial sophistication and ability to sustain investment losses or fend for themselves render registration under the Act unnecessary. Much like the economy, the base of accredited investors should be dynamic and reflect changing trends over time. This recalibrated definition seems to address these characteristics to protect and benefit both issuers and investors. If an investor has the financial sophistication and wherewithal to request and evaluate information to decide whether and how much to invest, and the bargaining power to obtain that information, then it may not be necessary for that individual to demonstrate that he or she has the ability to sustain losses.

Overall, the amendments seek to strike a balance between access to capital and investment risk. A fundamental objective of the accredited investor definition is to create bright-line tests that allow market participants to readily determine an investor’s status under the definition. In pursuit of that objective, the need for clarity is particularly important because an issuer relying on an exemption from registration carries the burden of proving that the exemption is available.

Next Steps

The amendments become effective 60 days after publication in the Federal Register. Following the effective date, issuers should include updated investor representations made in investment agreements or similar contractual instruments that incorporate the new accredited investor definition. Until then, the former definition still applies.

If you have questions regarding accredited investors, raising capital, or the implications of these amendments, please contact one of Hanson Bridgett’s corporate attorneys.