SEC Expands Definition of Accredited Investor
Updated: Nov 16, 2020
The Securities and Exchange Commission (SEC) adopted an expansion pf the definition of “accredited investor”. The new rule permits a greater number of investors to participate in private offerings. The rule formally includes knowledgeable employees as accredited investors, broadens the accredited investor definition to certain entities like family offices and limited liability companies, and extends the definition of accredited investor to include certain licensed professionals. The rule does not raise the standards for individual income ($200,000 for an individual, $300,000 for a married couple) or net worth ($1,000,000)
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. Tribal governments and other organizations may now qualify to participate in certain private offerings.
The new rule will become effective in early November.
Under existing law, an issuer generally may sell an unlimited amount of securities to (i) up to 35 non-accredited investors and (ii) an unlimited number of “accredited investors.” A purchaser is an accredited investor if an issuer “reasonably believes” that, at the time of the sale, the purchaser meets one of eight categories in the rule
In this rule, rather than increasing financial thresholds, it included new criteria that serve as additional proxies for meeting the underlying objectives 0f defining the investors with sufficient financial sophistication, access to information or ability to withstand investment loss to justify an exemption.
The new rule adds new categories that permit individuals to qualify as accredited investors based on certain professional certifications, designations or other credentials, or, with respect to investments in a private fund, based on the person’s status as a “knowledgeable employee” of the fund.
In addition, for purposes of the $1 million joint net worth requirement , the new rule adds a note that “joint net worth” is the aggregate net worth of the investor and his or her “spousal equivalent,” which encompasses any cohabitants occupying a relationship generally equivalent to that of a spouse. It also says an investor relying on the joint net worth test does not need to purchase the security jointly.
The new rule allows an individual with certain investment-related professional certifications, designations or other credentials to qualify as an accredited investor. The SEC designated individuals who are Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65) and Licensed Private Securities Offerings Representative (Series 82) as accredited investors.
The new rule also provides a list of factors for the SEC to consider in issuing additional orders to include a designation, including whether (1) the credential arises out of examinations administered by a self-regulatory organization or educational institution: (2) such examinations are reasonably designed to demonstrate an individual’s knowledge with respect to securities and investing: (3) the person with the credential can reasonably be expected to have sufficient knowledge to evaluate prospective investments; and (4) the credential is made publicly available. In addition, the individual is required to maintain such credentials in good standing, if applicable.
The new rule says “knowledgeable employees,” are accredited investors. Another rule already provided that securities owned by knowledgeable employees are excluded in determining whether the securities of a fund are owned exclusively by qualified purchasers. The new rule now says such employees also meet the accredited investor standard. Additionally, sponsors of funds are no longer required to count their otherwise non-accredited knowledgeable employee investors toward the non-accredited investor limit. A knowledgeable employee’s accredited investor status extends to his or her spouse with respect to joint investments in relevant private funds.
The new rule expands the types of entities that qualify as accredited investors, adds a “catch-all” category for entities with $5 million in investments, clarifies the current ownership look-through provision and permits certain family offices to qualify.
The new rule says “family offices” with at least $5 million in assets under management and their “family clients” as accredited investors so long as the entity is not formed specifically for the purpose of acquiring the offered securities and the 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.
LLCs have been added such that LLCs with total assets in excess of $5 million are now considered accredited investors. The SEC believes managers of qualified LLCs can still be accredited by virtue of their status as an “executive officer”
The new rule also creates a new “catch-all” category of accredited investors for entities with $5 million in investments that were not formed for the specific purpose of acquiring the offered securities. This provision captures, among other entities, American Indian tribes, labor unions, government bodies and funds, and entities organized under the laws of a foreign country.
Under the new rule, investment advisers registered under the Advisers Act or under state law are deemed accredited investors. Exempt reporting advisers are also included as qualified accredited investors.
Rural Business Investment Companies (RBICs) are also included in the types of entities that are deemed accredited investors. The new rule provides that an RBIC would qualify based solely upon its status as an RBIC.
The rule allows an entity to qualify as an accredited investor if all of the entity’s equity owners are accredited investors. Given that an equity owner of an entity may be an entity rather than a natural person, the new rule adds a note to clarify that an issuer may look through the various forms of equity ownership to the ultimate natural person owners in determining whether such owners are accredited investors.