Of particular interest as private capital markets activity continues to grow, the “accredited investor" definition is one of the principal tests for determining who is eligible to participate in investment opportunities presented by the private capital markets. On August 26, 2020, the SEC announced that it adopted amendments to the definitions of “accredited investor" in Rule 501, as well as the definition of “qualified institutional buyer" in Rule 144A, each under the Securities Act of 1933. These amendments are part of the SEC's ongoing efforts to simplify, harmonize and improve the framework for securities offerings that are not registered with the SEC under the Securities Act (for more information on this initiative, see our prior Monitor post here).
The definition of an “accredited investor" is utilized to determine whether a securities offering qualifies under Securities Act Regulation D as a private offering that does not require filing and clearing a registration statement with the SEC. But the definition is also widely used outside of the Regulation D context for assessing private offerings. Currently, the test for an individual to qualify as an accredited investor relies almost exclusively on that individual's income and net worth, regardless of their financial sophistication, an approach that SEC Chairman Jay Clayton called “unsatisfactory" in a public statement regarding the changes. The amendments update this framework, which had remained substantially unchanged for over 35 years, by revising the definition to include individuals with specified knowledge and expertise, in addition to those who meet the original tests. “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," said Chairman Clayton.
The amendments were approved by a 3-2 vote, with Commissioner Allison Herren Lee and new Commissioner Caroline Crenshaw dissenting. In a joint statement, Commissioners Lee and Crenshaw, both members of the Democratic party, voiced their disappointment that the Commission failed to index for inflation the existing net worth and income thresholds in the definition of accredited investor or to take additional steps to protect investors, particularly seniors, from fraud in the less transparent private capital markets. Even though Commissioner Hester M. Peirce voted to approve the amendments, she expressed concern in her public statement about the new concept of the SEC's “evaluating the merits of degrees or courses at specific accredited educational institutions."
The approved amendments include the following revisions:
- Added a new category to the definition of accredited investor that permits natural persons to qualify based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order;
- In conjunction with the adoption of the amendments, the Commission issued an order designating holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.
- With respect to investments in a private fund, included as accredited investors natural persons who are “knowledgeable employees" of the fund;
- Clarified that limited liability companies with $5 million in assets may be accredited investors and 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 to the accredited investor definition 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 were not formed for the specific purpose of investing in the securities offered;
- Added to the definition of accredited investor “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; and
- Added the term “spousal equivalent" to the accredited investor definition, so that spousal equivalents (not only “spouses") may pool their finances for the purpose of qualifying as accredited investors.
- Expanded the definition of “qualified institutional buyer" to include:
- limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition; and
- 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 in securities owned and invested threshold.
The Commission also adopted conforming amendments to other rules so that the new definition will apply for all references to the term “accredited investor" across the Securities Act and the Securities Exchange Act of 1934.
The amendments and the accompanying order will become effective 60 days after their publication in the Federal Register.
Special appreciation to associates Will Bald and Rodrigo Surcan for their work on this article.