On December 18th, 2019, the Securities and Exchange Commission (SEC) proposed modifications to modernize the existing accredited investor definition in the Commission’s rules, and the definition of a qualified institutional buyer in Rule 144A of the Securities Act of 1933.
These standards are part of the requisite conditions for eligibility to take part in the private capital marketplace. Accredited investor qualification is significant because it enables individuals and entities to take advantage of investment opportunities that are typically inaccessible to non-accredited counterparts, including investments in private corporations and offerings by specific hedge funds, private equity funds, and venture capital funds.
The proposed amendments would provide alternative methods for accredited investor qualification, enabling more investors to take part in private offerings based on their professional background. The changes would also expand the number of entities that may be considered institutional buyers.
The SEC released a concept release in June of 2019, seeking public input on the potential methods to enhance the exempt offering model of the Securities Act in order to stimulate capital formation and increase investments, while sustaining sufficient investor safeguards. The concept release sought to update the definition of an accredited investor, which is crucial to a number of exemptions from registration, including Rules 506(b) and 506(c) of Regulation D, and serves a central function in additional federal and state securities law matters.
Following an evaluation of the submitted commentary from the public, the SEC’s Small Business Capital Formation Advisory Committee, the SEC’s Investor Advisory Committee, and the Forum on Small Business Capital Formation, the Commission proposed changes to the accredited investor definition as a first step towards harmonizing the exempt offering system.
The definitional changes proposed by the SEC would incorporate additional categories of natural persons premised on professional knowledge, experience, or certifications. The amendments would additionally create more entity categories, as well as include a “catch-all” categorization for any entity that owns over $5 million in investments. Furthermore, the changes would add Limited Liability Companies and Rural Business Investment Companies to the forms of entities that are eligible for accredited investor status.
Key amendments to the accredited investor definition, proposed by the SEC:
- Create additional categories permitting natural persons to achieve accredited investor status based on professional certifications, designations, or experience that demonstrate an advanced understanding of securities and investing. This SEC is inviting comment as to whether this should include one or more of the following: Series 7, 65, 66 or 82 exams; CPA exam; CFA exam; CMA exam; investment adviser representative or registered representative (RR) exam; attaining an MBA from an accredited institution; having a CIMA certification; or having experience in the securities market as a broker, lawyer, or accountant.
- Allow knowledgeable employees of a given fund to become accredited investors in that private fund. Knowledgeable Employees would encompass trustees and advisory board members, or individuals operating in a similar function of a Section 3(c)(1) or 3(c)(7) fund. The definition would also include an affiliated individual of the fund responsible for the fund’s investments, in addition to employees of the private fund or the affiliated person of the fund, who participate in the investment activities of the private fund for at least one year.
- Allow limited liability companies to become accredited investors if they have net assets over $5 million and were not established for the sole purpose of securities acquisition. The rule currently does not include limited liability companies.
- Add an additional accredited investor category for all entities, to include Indian tribes, that own over $5 million in investments and that were not established for the purpose of investing in the securities being offered.
- Permit family offices with a minimum of $5 million in assets being managed, and their affiliated family clients, to qualify as accredited investors.
- Insert the term “spousal equivalent” into the existing accredited investor definition, so that cohabitating individuals occupying a similar relationship can pool their assets in order to become accredited investors.
The SEC is inviting the public to comment on these proposed changes and to give feedback on further changes that should be incorporated. However, the public has less than 60 days to submit comments on this proposal. Consider how you can get involved in responding to the SEC’s proposed amendments.
