The Securities and Exchange Commission (SEC) adopted amendments on Wednesday to portions of Regulation S-K and to the definitions of “accredited investor” and “qualified institutional buyer." The amendments are part of the SEC’s overall initiative to improve disclosure effectiveness and are intended to simplify compliance and ease accessibility without significantly altering the total mix of information provided to investors. The amendments to portions of Regulation S-K will be effective 30 days after publication in the Federal Register while the amendments to the definitions of “accredited investor” and “qualified institutional buyer” will be effective 60 days after publication in the Federal Register.
Amendments to Regulation S-K
The amendments revise Item 101 (description of business), Item 103 (legal proceedings) and Item 105 (risk factors) of Regulation S-K – disclosures that are required in many Securities Act and Exchange Act forms. These disclosure requirements have not undergone significant revisions in over 30 years. The SEC stated that these amendments reflect the many changes in our capital markets and the domestic and global economy in recent decades.
Below is a summary of the amendments:
- Item 101(a) (General Development of the Business):
- now will require disclosure of information material to an understanding of the general development of the business;
- replaces the previously prescribed five-year timeframe with a “materiality” framework; and
- permits companies, in filings made after their initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since the most recent full discussion of the development of its business (which will be incorporated by reference).
- Item 101(c) (Narrative Description of the Business):
- clarifies and expands the SEC’s “principles-based” approach, with a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c);
- includes, as a potential new disclosure topic, a requirement for a description of the company's human capital resources to the extent such disclosures would be material to an understanding of the company’s business; and
- refocuses the regulatory compliance disclosure requirement by including as a topic all material government regulations, rather than only environmental laws.
- Item 103 (Legal Proceedings):
- expressly states that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document (e.g., financial statement footnotes); and
- implements a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions – increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but also affords flexibility by allowing the company, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the company’s current assets.
- Item 105 (Risk Factors):
- requires a risk factor “summary” of no more than two pages if the risk factor section exceeds 15 pages;
- requires disclosure of "material" risk factors; and
- requires risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
Amendments to Definition of “Accredited Investor” and “Qualified Institutional Buyer”
The “accredited investor” definition, historically, has been one of the principal tests for determining who can participate as an investor in the private capital markets. Individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied opportunities to invest in the private markets. The SEC stated that the amendments to the definition of accredited investor update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in the private markets irrespective of their income or net worth. The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.
Below is a summary of the amendments:
- Rule 501(a) (Regulation D Accredited Investor Definition):
- adds a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons;
- includes as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- clarifies that limited liability companies with $5 million in assets may be accredited investors and adds SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- adds a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
- adds “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
- adds the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.
- Rule 215 (Accredited Investor definition for purposes of Securities Act section 2(15)(ii)):
- replaces the existing definition with a cross reference to the definition in Rule 501(a).
- Rule 144A (Private Resales of Securities to Institutions):
- expands the definition of “qualified institutional buyer” to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition; and
- adds to the list of qualifying institutions any institutional investors included in the accredited investor definition (in Rule 501) that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
The Commission also adopted conforming amendments to Securities Act Rule 163B (“test the waters” communications to qualified institutional buyers or institutional accredited investors) and to Exchange Act Rule 15g-1 (certain transaction exemptions from the “penny stock” rules).
We will follow this announcement with a more detailed analysis of the new rules in the upcoming days. A link to the SEC’s announcement regarding the amendments to Regulation S-K can be found here and the definition of accredited investor can be found here.