SEC Proposes Changes to the Definition of an Accredited Investor
On Wednesday, December 18, 2019, the U.S. Securities and Exchange Commission (the "SEC") voted to propose amendments to the definition of "accredited investor." Accredited investors have access to private, unregistered capital offerings, based on the assumption that their status means that such investors have the sophistication and means to participate in high-risk private offering transactions. The proposed amendments expand the definition of accredited investor in Rule 501 of Regulation D.
The current definition of accredited investor, which has been in effect since 1982, depends primarily upon income and net worth to identify natural persons who would qualify. An individual who earns at least $200,000 annually, individually, or $300,000 together with a spouse, qualifies, so long as the investor earned that income level for the two years prior to making the investment and expects to continue to earn at least the same amount in the coming year. Alternatively, an individual investor with a net worth (not including one's primary residence) of at least $1 million would qualify.
On June 18, 2019, the SEC issued a concept release that solicited public comment on proposals to simplify and harmonize the current framework for offerings in private capital markets. After reviewing public responses to its concept release, the SEC voted to amend the accredited investor definition as an initial step towards improving access to private capital markets, while maintaining appropriate investor protections. The proposed amendments maintain the current criteria for an accredited investor and expand it, potentially increasing the pool of accredited investors. The commissioners intend the proposed amendments to identify investors that have sufficient knowledge and expertise to enable them to invest in private capital markets without the additional protections afforded by the registration process.
If the proposed amendments are adopted, they will add two new qualifications for natural persons to satisfy the definition of an accredited investor. An individual who possesses certain professional credentials, demonstrating a background and understanding in securities and investments, will now qualify as an accredited investor. For example, holders of a Series 7, 65, or 82 license would now qualify as accredited investors, on the understanding that they have achieved the level of financial sophistication to participate in private capital markets. The specific qualifying credentials are not specified in the proposed amendments. Rather, the SEC would set the qualifying criteria by issuing an order, after adopting the final rules. In addition to individuals who possess certain relevant certifications and designations, the definition of accredited investor will expand to include knowledgeable employees of private funds. The SEC perceives such individuals as likely to be financially sophisticated through their knowledge and active participation in the investment activities of the private fund.
The proposed rule changes also add the term "spousal equivalent" to the financial test for qualifying as an accredited investor. This change would allow an individual investor to pool finances with a cohabitant who occupies a relationship generally equivalent to a spouse, for purposes of qualifying as an accredited investor. The spousal equivalent concept thus includes civil unions and domestic partnerships for purposes of pooling financial resources.
In addition to changes affecting how natural persons can qualify as accredited investors, the proposed rule changes also expand several categories of entities that may qualify as accredited investors. Currently, accredited persons include entities such as banks, insurance companies, certain employee benefit plans, investment companies, and small business investment companies. The proposed amendments would allow registered investment advisers, rural business investment companies, and limited liability companies that have total assets in excess of $5 million to qualify as accredited investors. In addition to limited liability companies, the proposed rule changes would add entities owning investments in excess of $5 million, which were not formed for the specific purpose of acquiring the securities being offered, to the definition of accredited investor. This change is intended to capture all existing entity forms, including Indian tribes and governmental bodies, as well as future entity types that may emerge. The proposed amendments also clarify that an entity will qualify as an accredited investor if all of its equity holders are accredited investors, adding a note to allow issuers to look through layers of ownership to evaluate whether the natural person behind the investing entity would satisfy the accredited investor criteria.
The proposed amendments also add new categories to the definition of accredited investor to include "family offices" and "family clients of family offices." To qualify, the family office must have a minimum of $5 million of assets under management and must not have been formed for the specific purpose of acquiring the securities being offered.
The SEC also proposes to make certain changes to the definition of qualified institutional buyers, for purposes of satisfying the safe harbor exemption from registration under Rule 144A. These changes are intended to harmonize the categories of entities that can be considered accredited investors under Rule 501 with qualified institutional buyers under Rule 144A, subject to satisfying the minimum threshold of $100 million in owned and invested securities.
The proposed amendments were published in the Federal Register for public comment on December 18, 2019. They are open to public comment for 60 days, after which the SEC will issue the final rule.