The SEC recently adopted amendments to Rule 501(a) of Regulation D of the Securities Act of 1933 that expand the definition of “accredited investor” by adding new categories of eligibility based on professional knowledge, experience, certifications, and other characteristics relevant to individuals and entities that invest in private securities. Ultimately, the amendments allow individuals and entities to participate in private capital markets not only based on their income or net worth but also based on clearly defined measures of financial sophistication and expertise. The amendments become effective on December 8, 2020, and private fund clients should consider updating their subscription agreement forms and investor questionnaires as soon as possible.
The following is a summary of the key expansions to the definition:
1. Professional Certifications, Designations, or Credentials. The amendments add a new category that will allow investors to qualify solely on the basis of holding certain professional certifications and licenses that demonstrate knowledge and experience in securities and investing. The new rules designate individuals holding a Series 7 (licensed general securities representative), Series 65 (licensed investment adviser representative), or Series 82 (licensed private securities offerings representative) license as accredited investors, even if they do not otherwise meet the income and net worth requirements in the existing definition. In addition, the SEC provided the framework for expanding the list of certifications and licenses that may qualify in the future.
2. Knowledgeable Employees of Private Funds. Under the amendments, “knowledgeable employees” of a private fund may now qualify as accredited investors for investments in the fund. “Knowledgeable employees” include: (a) executive officers, directors, trustees, general partners, advisory board members, or persons serving in a similar capacity of a private fund, or affiliated persons of the fund who oversee the fund’s investments, as well as (b) employees or affiliated persons of the fund (other than employees performing solely clerical, secretarial, or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of the private fund for at least 12 months.
3. Family Offices and Family Clients. The amendments designate “family offices” (as defined by the “family office rule” set forth in Rule 202(a)(11)(G)-1 of the Investment Advisers Act) as accredited investors if they meet the following requirements:
- The family office has at least $5 million in assets under management;
- It is not formed for the specific purpose of acquiring the securities offered; and
- Its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that the family office is capable of evaluating the merits and risks of the prospective investment.
“Family clients” (i.e., individuals and entities whose prospective investments are directed by their family office) will also be designated as accredited investors under the amendments.
4. Other Entities. The amendments also add the following categories of entities that will qualify as accredited investors:
- Investment advisers that are registered with the SEC or a state securities authority as an investment adviser, or that file reports with the SEC as an exempt reporting adviser (e.g., a mid-sized private fund adviser or an adviser solely to venture capital funds).
- Rural business investment companies (RBICs).
- Limited liability companies that have not been formed for the purpose of making the applicable investment and that have total assets in excess of $5 million will qualify as “accredited investors.”
- Any type of entity owning “investments” in excess of $5 million and that is not formed for the specific purpose of investing in the securities offered. For this category, “investments” are defined by reference to Rule 2151-1(b) under the Investment Company Act, which is used to determine an investor’s status as a “qualified purchaser.”
5. Spousal Equivalent. Under the existing definition, an individual, together with a spouse, may be accredited if the individual has at least $300,000 in joint income in the two most recent years or at least $1 million in joint net worth. The amendments broaden the definition of spouse to include “spousal equivalents” (i.e., a cohabitant occupying a relationship generally equivalent to that of a spouse).