On August 26, 2020, the US Securities and Exchange Commission (the SEC) adopted amendments to Rule 215 and Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended (the Securities Act), which expanded the definition of “accredited investor” (the Accredited Investor Amendment). In conjunction with the Accredited Investor Amendment, the SEC also adopted amendments to the definition of “qualified institutional buyer,” or “QIB,” under Rule 144A of the Securities Act (the QIB Amendment and, together with the Accredited Investor Amendment, the Amendments). The Amendments expand the pool of eligible investors in exempt private offerings, which may provide additional sources of capital to business development companies, closed-end funds and other private funds (collectively, the Funds).
To summarize, the Amendments:
- expand the definition of “accredited investor” to add new categories of natural persons and entities that can qualify, irrespective of their wealth;
- expand the entities eligible as QIBs under Rule 144A offerings to be consistent with the Accredited Investor Amendment; and
- amend certain related rules (e.g., testing the waters under Rule 163B).
The Amendments are part of the SEC’s broader, ongoing effort to simplify, harmonize and improve the exempt offering framework. In 2015, the SEC conducted a comprehensive review of the accredited investor definition (the 2015 Report)1, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires a review of the “accredited investor” definition every four years. The 2015 Report highlighted a number of criticisms of the accredited investor definition. For example, some criticized the prior definition of “accredited investor” as an imperfect proxy for determining an individual’s ability to assess the risks of participating in exempt private offerings under Regulation D, which do not have the rigorous disclosure and procedural requirements provided by the Securities Act for registered offerings. Others criticized the prior definition as being over-inclusive, because the financial thresholds have not been amended since they were adopted in 1982.
Prior definition of “accredited investor”
The prior definition of “accredited investor” relied exclusively on certain financial thresholds to identify persons that the SEC deemed financially sophisticated enough to participate in exempt private offerings. Specifically, the prior definition of “accredited investor” included (1) certain entities with total assets in excess of $5 million or (2) any natural persons whose (x) individual net worth (or joint net worth with that person’s spouse) exceeds $1 million or (y) individual income exceeds $200,000 (or joint income with that person’s spouse exceeds $300,000) in each of the last two years (collectively, the Prior Definition).
Prior definition of QIB
Under the prior definition, to qualify as a QIB, an entity must, in the aggregate, own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the QIB. Banks and other specified financial institutions that have a net worth of $25 million also qualify. Finally, a registered broker-dealer qualifies as a QIB if, in the aggregate, it owns and invests on a discretionary basis at least $10 million in securities of issuers that are not affiliated with the broker-dealer.
Amendment to definition of accredited investor
The Accredited Investor Amendment added new categories of natural persons and entities that can qualify as “accredited investors” under Regulation D, including the following:
- An individual that holds in good standing certain professional certifications, designations or credentials from an accredited educational institution that the SEC has designated as sufficient to demonstrate that individual’s investment knowledge (e.g., Series 7, 65 or 82 license), and the SEC may expand the list of eligible certifications and credentials in the future by order; and
- An individual that is a “knowledgeable employee” of a private fund issuer2 of the securities being offered or sold, as such term is defined in Rule 3c-5(a)(4) of the Investment Company Act of 1940, as amended (the 1940 Act).
- An investment adviser registered under the Investment Advisers Act of 1940, as amended (the Advisers Act) or an investment adviser exempt from registration;
- A “family office” (as defined in Rule 202(a)(11)(G)-1 of the Advisers Act) with more than $5 million in assets under management and its family clients, subject to certain requirements;
- Limited liability companies (LLCs) that meet the conditions currently applicable to corporations;3 andRural business investment companies.
Notably, the SEC declined to revise the net worth and income thresholds discussed above, despite the fact that the thresholds have not been amended (or adjusted for inflation) since they were adopted in 1982.
Amendments to definition of QIB
In conjunction with the Accredited Investor Amendment, the SEC also expanded the pool of eligible QIBs under Rule 144A of the Securities Act to avoid inconsistencies with entities eligible for accredited investor status under the Accredited Investor Amendment. Specifically, the QIB Amendment expanded the definition to include LLCs and rural business investment companies, if such companies meet the $100 million threshold. Further, the QIB Amendment added a “catch-all” provision that includes any entity that would qualify as an accredited investor that (i) is not otherwise enumerated in Rule 144A and (ii) still meets the $100 million threshold.
Amendment to testing the waters
The SEC also expanded the types of entities that can receive “testing the waters” communications under Rule 163B of the Securities Act prior to a registered offering (the 163B Amendment). The 163B Amendment was adopted in order to avoid inconsistencies with the categories of institutional investors that were added by the Amendments.
Impact of the Amendments
Generally, the Amendments are intended to more effectively identify investors that have sufficient knowledge and expertise to participate in certain exempt private offerings that do not have the rigorous disclosure and procedural requirements provided by the Securities Act for registered offerings. The Amendments may allow certain financially sophisticated investors who were previously excluded from exempt private offerings solely because they did not meet the net worth and income tests to participate in such offerings, thereby increasing the amount of capital available to Funds. Although the SEC has acknowledged that it does not anticipate the number of newly eligible accredited investors and QIBs to be significant compared to the number of currently eligible accredited investors and QIBs, the Amendments signify the SEC’s willingness to consider further expansions and reevaluate the credentials necessary and appropriate for participation in exempt private offerings. For example, as noted above, the SEC reserved the ability to designate by order additional professional certifications or credentials that may qualify an individual for accredited investor status. Therefore, the SEC can expand the pool of natural persons eligible for accredited investor status in the future without the time-consuming process of notice and comment. The SEC will also have the opportunity to consider the impact of the Amendments and evaluate the necessity of further expansions in 2023, when it is required to undertake its next review of the “accredited investor” definition.
For now, Funds should review their offering memoranda, subscription agreements and related offering materials to determine what, if any, changes are necessary to incorporate the new accredited investor and QIB definitions. The Amendments will become effective 60 days after publication in the Federal Register.
1 The SEC’s 2015 report is available at https://www.sec.gov/files/review-definition-of-accredited-investor-12-18-2015.pdf.
2 Notably, the “knowledgeable employee” expansion only covers employees of private fund issuers that rely on the exemptions from registration under the 1940 Act contained in Sections 3(c)(1) and 3(c)(7) thereunder, and does not apply to employees of BDCs or registered closed-end funds.
3 This amendment codifies the SEC’s longstanding position with respect to LLCs under the definition of “accredited investor.”