On August 26, 2020, the SEC adopted amendments to the definition of “accredited investor” in Regulation D and “qualified institutional buyer” (QIB) in Rule 144A under the Securities Act of 1933 (Securities Act).1 The changes to the accredited investor definition, which represent the most significant substantive changes since the adoption of Regulation D in the early 1980s, add much needed clarification of the status of certain institutional investors as accredited investors and expands the categories of entities and persons meeting the definition. In an effort to create consistency with the amended accredited investor definition, the amendments to the QIB definition expand the list of eligible entities.
These amendments are intended to update and improve the exempt offering framework to promote capital formation and to identify more effectively institutional and individual investors that have sufficient knowledge and expertise to participate in investment opportunities that do not have the protections provided by registration under the Securities Act. Significantly, the amendments do not change the income and wealth thresholds in the accredited investor definition, which resulted in two Commissioners voting against approval of the rules. The dissenting Commissioners believed that the income and net worth thresholds should have been adjusted in some way to reflect inflation and/or geographic considerations. The amendments will take effect 60 days after publication in the Federal Register.
Amendments to the Accredited Investor Definition
The amended definition provides that, notwithstanding the income and net worth thresholds, individuals with certain qualifying professional certifications, designations, and other credentials, as set forth in a separate SEC order, are accredited investors. The separate order provides that persons holding a Series 7, Series 65 or Series 82 license in good standing, are accredited investors.2 The SEC may add additional qualifying professional certifications, designations and other credentials in the future by order, after notice and a public comment period.3
The amended definition also provides that a “knowledgeable employee,” as defined in Rule 3c-5 under the Investment Company Act of 1940 (1940 Act), of a private fund,4 qualifies as an accredited investor with respect to investments in the private fund. Rule 3c-5 defines a knowledgeable employee of a private fund to include: (i) an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity of the private fund or an affiliated management person (as defined in Rule 3c-5(a)(a)) of the private fund; and (ii) an employee of the private fund or an affiliated management person of the private fund who, in connection with his or her regular functions or duties, participates in the investment activities of that private fund or other private funds or investment companies managed by the private fund’s affiliated management person, provided that such person has performed such functions and duties for or on behalf of such entities, or another similar company, for at least 12 months.
The amended definition allows individuals to include joint income from spousal equivalents when calculating joint income under Rule 501(a)(6), and to include spousal equivalents when determining net worth under Rule 501(a)(5). A “spousal equivalent” is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse, which is the definition used in other SEC rules.
The amendment also adds a note to clarify that the calculation of joint net worth for purposes of Rule 501(a)(5) can be the aggregate net worth of an investor and his or her spouse or spousal equivalent (rather than including only jointly-held assets), and the securities being purchased do not need to be purchased jointly.
Registered Investment Advisers
The amended definition includes SEC- and state-registered investment advisers as well as exempt reporting advisers.6 The Adopting Release states the SEC’s belief that registered investment advisers, even those that are sole proprietorships, have the requisite financial sophistication needed to conduct meaningful investment analysis, and notes that registered investment advisers are generally considered to be institutional investors under state securities laws.7
Rural Business Investment Companies
The amended definition includes Rural Business Investment Companies (RBICs). RBICs are intended to promote economic development and the creation of wealth and job opportunities in rural areas and among individuals living in rural areas. The Adopting Release notes that RBICs serve a purpose similar to the purpose of small business investment companies (SBICs), which were already accredited investors under Rule 501(a)(1).
Limited Liability Companies
The amended rule adds limited liability companies to the list of entities that may qualify as accredited investors under Rule 501(a)(3), codifying existing SEC staff guidance. Rule 501(a)(3) requires the listed entities to have more than $5 million in total assets and not be formed for the specific purpose of acquiring the securities being offered.
Other Entities Meeting an Investments-Owned Test
The amended rule also includes a new category of accredited investor that includes any entity not otherwise identified as an accredited investor that owns more than $5 million in investments8 and was not formed for the specific purpose of acquiring the securities being offered.
Family Offices and Family Clients
The amended definition includes family offices that have at least $5 million in assets under management and were not formed for the specific purpose of acquiring the securities offered, and whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters as can assure that the family office is capable of evaluating the merits and risks of the prospective investment.9 A family client of a family office that meets these requirements also qualifies as an accredited investor if the prospective investment is directed by the family office.10 This addition to the definition is very significant not only to family offices, which were not previously accredited investors, but also to family clients, who may now make the investment out of their own assets, instead of the assets of the family office, and still be considered accredited investors. This will increase the investment opportunities for family offices and their family clients.
Proposed Amendments to the QIB Definition
The amendments to the QIB definition are intended to ensure that entities that qualify as accredited investors also qualify as QIBs when they meet the $100 million in securities owned and invested threshold in the QIB definition. Consequently, the QIB definition adds RBICs and LLCs to the list of entities that are eligible to become QIBs and includes entity types not already included in the definition to qualify if they satisfy the asset test.
The SEC also adopted conforming amendments to Rule 163B under the Securities Act and Rule 15g-1 under the Securities Exchange Act of 1934.
These rule amendments rationalize and update definitions that have long been in need of updating. The SEC essentially “punted” on the question of whether the income or wealth thresholds for individual investors should be updated in light of inflationary or geographic considerations, resulting in a 3-2 vote of the SEC. This issue will likely be considered in the SEC’s quadrennial review of the accredited investor definition required by the Dodd-Frank Act, which will be conducted in 2023. If you would like to discuss these rule changes in more detail, please contact Steve King, author of this Legal Insight, or one of the Practus attorneys with whom you work.
- Amending the “Accredited Investor” Definition, Securities Act Rel. No. 10824 (Aug. 26, 2020) (“Adopting Release”).
- Order Designating Certain Professional Licenses as Qualifying Natural Persons for Accredited Investor Status Pursuant to Rule 501(a)(10) under the Securities Act of 1933, Securities Act Rel. No. 10823 (Aug. 26, 2020).
- The criteria that the SEC will consider in determining whether to make additions are set forth in the Rule 501(a)(10).
- A private fund is an issuer that would be an investment company, as defined in Section 3 of the 1940 Act, but for Sections 3(c)(1) or 3(c)(7) of the 1940 Act.
- Under Rule 501(a)(8), private funds with assets of $5 million or less may qualify as accredited investors if all the fund’s equity owners are accredited investors. The amended rule adds a note clarifying that it is permissible to look through various forms of equity ownership to natural persons in determining the accredited investor status of entities under Rule 501(a)(8).
- An exempt reporting adviser is an investment adviser that qualifies for the exemption from registration under Section 203(l) of the Advisers Act because it is an adviser solely to one or more venture capital funds, or under Rule 203(m)-1 of the Advisers Act because it is an adviser solely to private funds and has assets under management in the United States of less than $150 million.
- It is important to note that the definition only includes registered investment advisers acting for their own account, and a client of a registered investment adviser would still need to qualify as an accredited investor independently. The SEC considered, but declined to include in the definition, clients of an investment adviser or customers of a broker-dealer.
- For purposes of the rule, “investments” is defined as in Rule 2a51-1(b) under the 1940 Act.
- Rule 501(a)(12).
- Id. “Family office” and “family client” are as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940.