On August 26, 2020, the Securities and Exchange Commission (the “SEC”) adopted final rules amending the definitions of both an “accredited investor” under Rule 501 of Regulation D and a “qualified institutional buyer” under Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”). The purpose of these amendments is to update and improve the definitions in order to identify individual and institutional investors which do not need the additional protections afforded by registration under the Securities Act.1
The immediate impact of these changes will be to expand the pool of potential accredited investors and qualified institutional buyers, which should, in turn, increase the capital available in private and Rule 144A offerings. Theoretically, these changes should make it easier for issuers to find and attract investors to purchase the securities in such offerings.
The definition of “accredited investor” is central to several exemptions for issuing securities, such as Rule 506(b) and Rule 506(c) of Regulation D. Accredited investor status serves as a proxy for financial sophistication and the ability to sustain the risk of loss or to properly evaluate the investment such that the investor is willing to bear the risk. Being considered an accredited investor is significant – certain investment opportunities may only be available to accredited investors, such as unregistered offerings in start-up and early stage companies, hedge funds, private equity funds and venture capital funds.
These amendments are part of a larger effort by the SEC to simplify, harmonize and improve the exempt offering framework under the Securities Act “to promote capital formation and expand investment opportunities while maintaining appropriate investor protections.”2 The final rules and the corresponding amendments will become effective 60 days after their publication in the Federal Register.
Expanded Definition of “Accredited Investor”
Broadly speaking, in the past, accredited investors were roughly defined to include only those individuals who were either officers of the issuer (i.e., generally directors and the most senior management team members) or met certain income or net worth thresholds for individuals and total asset thresholds for institutional investors. These measurements were used as a proxy for financial sophistication. In a step forward, through these amendments, the SEC introduced more qualitative measurements for investors to be considered accredited investors, such as professional certifications, designations or credentials, or “knowledgeable” positions within certain private funds. Effectively, the SEC has now determined that wealth alone should not be the sole means of establishing financial sophistication of an individual for the purposes of investing in private offerings. It is important to note that the SEC did not make any adjustments to the existing dollar threshold tests; thus, the financial threshold tests still apply as a means of being considered an accredited investor.
Specifically, the amendments to the definition of accredited investor include the following:
- Certain Designated Professionals – An individual, if her or she holds, in good standing, certain professional certifications, designations or credentials issued by an accredited educational institution. The SEC may designate from time to time which professional certifications, designations or credentials qualify based on certain specified criteria. At the moment, the SEC has only designated the following licenses as qualifying under this change: Series 7 (licensed general securities representative), Series 65 (licensed investment adviser representative) and Series 82 (licensed private securities offerings representative) licenses.
- Knowledgeable Employees – Individuals who are “knowledgeable employees,” as defined in Rule 3c-5(a)(4) of the Investment Company Act of 1940, as amended, of an issuer that is a private fund relying on the exclusion from the definition of “investment company” under Section 3(c)(1) or 3(c)(7) of the Investment Company Act. A “knowledgeable employee” is generally defined to include an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the Section 3(c)(1) or 3(c)(7) fund or an “affiliated management person” (an affiliated person that manages the investment activities of a private fund for at least 12 months) of the private fund. A knowledgeable employee’s accredited investor status will be attributed to his or her spouse with respect to joint investments made by the knowledgeable employee and his or her spouse in a private fund.
- Investment Advisors – SEC- and state-registered investment advisers, and exempt reporting advisers under Section 203(m) or Section 203(1) of the Investment Advisers Act of 1940, as amended.
- RBICs – Rural business investment companies (“RBICs”) as defined in Section 384A of the Consolidated Farm and Rural Development Act, as amended.
- Family Offices and Family Clients – “Family offices,” as defined in the Investment Advisers Act, with at least $5 million in assets under management and which are not formed for the specific purpose of investing in the securities being offered, and whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters such that the family office is capable of evaluating the merits and risks of the prospective investment. Any “family client” of a family office meeting the standards above is included.
- “Catch-All” Entities with Investments in Excess of $5 Million – Any entity may qualify as an accredited investor if it has investments in excess of $5 million and was not formed for the purposes of investing in the securities offered.
- LLCs with Assets in Excess of $5 Million – Codifying the SEC’s prior interpretation that limited liability companies can qualify, a limited liability company may qualify as an accredited investor if it has assets in excess of $5 million and was not formed for the purposes of investing in the securities offered.
- Spousal Equivalent – The term “spousal equivalent” was added to allow the pooling of finances to satisfy the joint income and net worth tests of the accredited investor definition. “Spousal equivalent” is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.
Expanded Definition of “Qualified Institutional Buyer”
The amendments also expand the definition of “qualified institutional buyer” for the purposes of Rule 144A. The definition will now include:
- Any limited liability company or RBIC so long as it owns and invests at least $100 million in securities of non-affiliated issuers.
- A catch-all for any institutional investors included in the definition of accredited investor that are not otherwise enumerated in this definition, provided that they satisfy the same $100 million threshold.
The amendments outlined above will serve to expand the pool of potential accredited investors and, theoretically, should make it easier for issuers to find and attract investors to purchase securities. Issuers, however, should be mindful of the effective date of these amendments. Issuers should consider updating their subscription agreements, purchase agreements, investor questionnaires and other offering documents to take advantage of, and comply with, the expanded definitions. One of our team members would be glad to assist with that analysis and process.
Womble Bond Dickinson regularly advises private and publicly-traded companies on SEC filings, exemptions and related matters. If you need assistance or have any questions regarding the issues discussed in this alert, please contact Jane Jeffries Jones at (704) 331-4953 or firstname.lastname@example.org, Sid Shenoy at (704) 331-4970 or email@example.com, Jake Rifkin at (704) 331-4906 or firstname.lastname@example.org, or the Womble Bond Dickinson attorney with whom you usually work for more information.
1 SEC Press Release Nos. 33-10734; 34-87784; File No. S7-25-19, Dec. 18, 2019, view here.