Just in time for the holidays, the U.S. Securities and Exchange Commission (“SEC”) gifted investors and other financial market participants with a notice of proposed changes to the “Accredited Investor” definition to expand access to private capital markets. The proposed rule would add new categories of persons that qualify as accredited investors based on professional knowledge, certifications, and investment holdings. Currently, the SEC is seeking comments from interested parties on the proposed rule change and will consider such comments when the SEC votes to adopt or reject the proposed rule change.
Specifically, the proposed rule would expand the accredited investor definition found in Regulation D, Rule 501 (17 CFR § 230.501(a)) to allow the following persons to qualify as accredited investors:
- SEC or state-registered investment advisers;
- Rural Business Investment Companies;
- Entities with assets in excess of $5 million and not formed for the specific purpose of purchasing the securities offered;
- Natural persons holding specific professional certifications or academic credentials that attest to the persons’ financial and investment acumen (the SEC will post a list of certifications and credentials that meet their standards on their website);
- Knowledgeable employees of the issuer where the issuer is excluded from qualifying as an investment company pursuant to section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (hedge funds commonly use these exclusions to avoid investment company registration);
- Family offices with assets in excess of $5 million, that is not formed for the specific purpose of purchasing the securities offered, and whose prospective investment is directed by a person with experience and knowledge in financial and business matters; and
- Certain family clients of a family office.
Also, the proposed rule allows for a natural person seeking to qualify as an accredited investor based on income or net worth to include that person’s spousal equivalent’s income and net worth in the calculation. A “spousal equivalent” is that person’s cohabitant that “occup[ies] a relationship generally equivalent to that of a spouse.”
At the same time, the SEC is proposing to amend Rule 144A, 17 CFR § 230.144A, so as to expand the definition of “qualified institutional buyers” to include many accredited investors that do not yet qualify for that status, which allows certain institutions to purchase securities in private resale transactions.
If an entity wants to raise capital to grow its business, the entity can either secure funding from a bank, borrow money from friends and family, raise money through a public offering of its stock and register such offering with the SEC, or raise money from the public pursuant to an exemption from SEC registration. One such exemption is Regulation D.
Generally, Regulation D allows entities to raise capital from accredited investors and a small number of other types of investors under certain conditions. With the expansion of the accredited investor definition, more investors may participate in Regulation D offerings, and entities will have a larger potential investor pool from which to raise money.
Furthermore, purchasers of securities bought in certain private offerings will be able to privately resell these securities to a greater number of institutions as more institutions qualify as “qualified institutional buyers.” Normally, securities purchases in private offerings are subject to significant resale restrictions, including a prohibition that they may not be resold for at least 6 months or a year (see 17 CFR § 230.144). However, the proposed rule would provide purchasers with greater liquidity, thus making the overall investment in the privately offered security more attractive.
The Commission’s Response
SEC Chairman Jay Clayton stated that the “modernization” of the accredited investor definition “is long overdue,” and Commissioners Elad L. Roisman and Hester M. Peirce released statements supporting the rule change. However, not all SEC commissioners shared their positive opinions. Commissioners Allison Herren Lee and Robert J. Jackson Jr. both expressed their concerns that the rule change would expose ordinary investors to greater financial risks.
As mentioned above, the SEC only proposed this amendment to the accredited investor definition. The SEC must allow the public to comment on the proposal. Interested parties, such as potential investors, issuers, qualified institutional buyers, and others are welcome to submit comments. Once the SEC reviews the comments, the SEC will hold another meeting to adopt or reject the amendments proposed. The SEC may also vote to adopt a version of the rule that is different from the one proposed.
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