The Expanded Definition of “Accredited Investor” Took Effect on December 8, 2020Securities Attorneys (Exchange Act)
By Yujia Wei and Amelia Smith
On August 26, 2020, the U.S. Securities and Exchange Commission (“SEC”) adopted amendments to the definition of “accredited investor,” a central component in the exempt offering framework, including Rules 506(b) and 506(c) of Regulation D. These amendments are part of an ongoing initiative to modernize the exempt offering framework and expand investment opportunities while maintaining adequate investor protections and promoting capital formation. The amendments went into effect on December 8, 2020.
Enlarged Scope of Individual Accredited Investors
The definition for “accredited investor” has remained largely the same for over three decades. Under the previous definition, individual investors had to meet specific income or net worth thresholds to qualify as an accredited investor. Specifically, an individual was required to have a net worth, or a joint net worth with the person’s spouse, of more than $1 million, excluding the value of the person’s primary residence, or an annual income in excess of $200,000 for the past two years, or a combined income with the person’s spouse of over $300,000 for the past two years. Such rules were designed to protect individual investors from the risks of relaxed regulatory oversight of private investments. The wealth threshold rests on the idea that these accredited investors would be experienced enough to both evaluate and mitigate high risk investments, as well as wealthy enough to survive heavy losses.
The amendments expand the definition of accredited investor to include alternatives to the binary wealth test for natural persons:
- The amendments add a new category to permit individuals to qualify as accredited investors if they hold certain professional certifications, designations and other credentials from accredited educational institutions that can reasonably be expected to have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment. Currently, the SEC has designated holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying individuals.
- The amendments also add a new category for individuals who are a “knowledgeable employee” of a private fund to be permitted to invest in the fund as accredited investors. The term “knowledgeable employee” is defined in rule 3c-5(a)(4) promulgated under the Investment Company Act of 1940 which generally includes executive officers, directors, trustees, general partners, advisory board members or persons serving in a similar capacity and affiliated persons managing the fund’s investment activities as well as employees who have participated in the fund’s investment activities for at least 12 months.
Further, the amendments supplement “spouse” with “spousal equivalent” in the wealth test to allow a cohabitant occupying a relationship generally equivalent to that of a spouse to pool finances for the purpose of qualifying as accredited investors.
Addition of Entity Accredited Investors
The amendments also expand the scope of entities that qualify as accredited investors.
- The amendments explicitly provide that any limited liability company (LLC), not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5 million qualifies as an accredited investor. This change is largely a recognition of SEC staff’s long-standing position that LLCs should have access to the accredited investors status as a corporation or partnership would.
- The amendments add SEC- and state-registered investment advisers, exempt reporting advisers and rural business investment companies (RBICs) to the qualifying entities.
- The amendments add a catch-all category such that any entity (such as Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries), not formed for the specific purpose of acquiring the securities offered, owning investments in excess of $5 million qualifies as an accredited investor.
- The amendments add new categories of “family offices” and “family clients.” In particular, a qualifying “family office” means a family office that has assets under management in excess of $5 million, not formed for the specific purpose of acquiring the securities offered, and whose investment is directed by a person with financial and business sophistication to evaluate investment risks. A “family client” who is the client of such qualifying family office will also satisfy the accredited investor status.
Qualified Institutional Buyer
The amendments also update the definition of “qualified institutional buyer” (the “QIB”) in Rule 144A. Rule 144A provides a safe harbor exemption from registration with respect to resales of restricted securities to QIBs. The amended definition of QIB serves to harmonize between the definitions of accredited investors and QIBs by making all types of entity accredited investors eligible for QIB status so long as they meet the $100 million in securities owned and invested threshold. As a result, the amendments have expanded the QIB definition to include LLCs and RBICs, as well as all entity types that qualify as accredited investors, provided that they satisfy the $100 million threshold.