SEC Adopts Amendments to “Accredited Investor” Definition

Emily HayesBest Practices, Market Rules & Responsibilities, Operations

SEC amends “accredited investor” definition

On August 26, 2020, the U.S. Securities and Exchange Commission (“SEC”) approved amendments to the “accredited investor” definition1, thereby increasing the number of persons that can participate in private offerings of securities2.  Previously, individuals that wanted to participate in private offerings generally had to be high earning or high net-worth individuals to qualify as “accredited investors.” The amended definition allows, among other changes, individuals to qualify as accredited investors based on their professional experience, knowledge, or certifications or educational attainment and adds new categories of entities that may qualify as well. The new definition will become effective 60 days after it is published in the Federal Register.3

Go-No-Go IPO

Normally, if a business wants to raise money by selling stock, bond, or other forms of securities, the business must register that offering with the SEC. This is no mean feat as even small public offerings can cost millions of dollars in underwriting, legal, accounting, and consulting fees4. Small companies with limited financial resources are often unable to afford the upfront and ongoing reporting costs of going public. 

To provide such companies with access to capital, the U.S. securities laws exempt certain offerings from the registration requirement. One such exemption is found in Regulation D promulgated under the Securities Act of 19335. Rules 506(b) and 506(c) of Regulation D allow entities to raise money from accredited investors if the entity abides by certain restrictions in each rule – such as verifying accredited investor status or not engaging in general solicitation. Thus, the definition of “accredited investor” acts as a gatekeeper to the world of private offerings: it limits who may participate in a private offering, and it limits from whom companies may raise capital. 

Amendments to Definition

Before the SEC approved the amendments, a natural person could qualify as an “accredited investor” if the person met a net worth or income standard. To meet the net worth standard, a natural person needs an individual net worth, or joint net worth with that person’s spouse, that exceeds $1,000,000, without counting equity from the person’s primary residence6. To meet the income standard, a natural person needs an individual income in excess of $200,000 in each of the 2 most recent years or joint income with that person’s spouse in excess of $300,000 in each of the 2 most recent years, and the person must have a reasonable expectation of reaching the same income level in the current year7. Thus, if an individual wanted to participate in an offering limited to accredited investors, that individual needed to be relativity wealthy. 

However, the amended definition allows for investors with sufficient knowledge and expertise to qualify as “accredited investors” regardless of their financial situation. The amended definition adds the following categories to the accredited investor definition:

 

  1. Any natural persons that hold in good standing one or more professional certifications or designations or credentials from an accredited educational institution that the SEC designates as qualifying an individual for accredited investor status (the SEC will designate the professional certification, designation, or credential by order, after notice and an opportunity for public comments, and the SEC will post the professional certifications, designations, or credentials it currently recognizes on its website)8;
  2. “Knowledgeable employees”9 of certain private funds10;
  3. Investment advisers registered with the SEC or with a state regulator or exempt from such registration pursuant to the venture capital fund advisers exemption11 or the private fund advisers exemption12;  
  4. Any Rural Business Investment Company as defined in Section 384A of the Consolidated Farm and Rural Development Act;
  5. Certain entities that are not formed for the purpose of purchasing the securities offered and that owns investments in excess of $5,000,000; and
  6. “Family offices” with at least $5,000,000 in assets under management and their “family clients.”13

In addition, under the revised rules, natural persons may meet the traditional net worth or income standard with a “spousal equivalent” and not just a spouse14.

The SEC also expanded the definition of “qualified institutional buyer” found in Rule 144A: Private Resales of Securities to Institutions15 to include limited liability companies, Rural Business Development Companies, and institutional accredited investors that meet the $100 million in securities owned and invested threshold. This will provide more liquidity in the private offering secondary market as it will increase the number of institutions to which a holder of securities purchased in a private offering (such as a Regulation D, Rule 506(b) or Rule 506(c) offering) may sell the securities.

Practical Guidance

If you are considering fundraising using Regulation D, Rule 506(b) or Rule 506(c), the new accredited investor definition will increase your company’s or fund’s access to capital. You should consider whether the new accredited investor definition expands your ability to fundraise.

If you are already engaged in a Regulation D, Rule 506(b) or Rule 506(c) offering, you should amend your offering documents and subscription or investor agreement to include the new categories of persons that qualify as accredited investors. Plan to have these new documents completed in about 2 months so when the new rule becomes effective, you are ready to accept investments from new accredited investors.

If you have any questions on how this new definition may impact you, your business, or your fund, please contact Emily Hayes at ehayes@ziliak.com.

 


1 See U.S. Securities and Exchange Commission,SEC Modernizes the Accredited Investor Definition,” Press Release (Aug. 26, 2020), and U.S. Securities and Exchange Commission, Release Nos. 33-10824, 34-89669, File No. S7-25-19, RIN 3253-AM19 (Aug. 26, 2020).

The SEC proposed to update the “accredited investor” definition in December 2019. See Hayes, Emily, “SEC Proposes Revisions to the “Accredited Investor” Definition,” Ziliak Law Blog (Jan. 18, 2020).

3 As of September 4, 2020, the Federal Register has not published the new rule.

See “Considering an IPO? First, understand the costs,” PWC (accessed Aug. 31, 2020), available at https://www.pwc.com/us/en/services/deals/library/cost-of-an-ipo.html.

17 CFR §§ 230.500-230.506.

17 CFR § 230.501(a)(5).

17 CFR § 230.501(a)(6).

The SEC already designated persons in good standing that hold the Series 7, 65, and 82 as meeting this standard.

“Knowledgeable employees” must meet the definition in Rule 3c-5(a)(4) under the Investment Company Act of 1940, 17 CFR § 270.3c-5(a)(4).

10 Here, “private funds” means issuers that would be investment companies but for the exclusions provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.

11 Investment Advisers Act of 1940, Section 203(l), 15 U.S.C. § 80b-3(l).

12 Investment Advisers Act of 1940, Section 203(m), 15 U.S.C. § 80b-3(m).

13 “Family office” and “family client” must meet the definitions found in Rule 202(a)(11)(G)-1 Under the Investment Advisers Act of 1940, 17 CFR § 275.202(a)(11)(G)-1.

14 A “spousal equivalent” is a cohabitant occupying a relationship generally equivalent to that of a spouse.

15 17 CFR § 230.144A.

Emily Hayes

Emily Hayes

Emily Hayes first began at Ziliak Law in the fall of 2016 as a law clerk and, after graduating from Law School, passing the Bar exam, and being sworn in to the Illinois Bar Association, joined us as an Associate.Read more...
Emily Hayes