SEC Expands Definition of Accredited Investor

Gray Reed

Gray Reed

On August 25, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments to the definition of “accredited investor” in Rule 501 promulgated under Regulation D of the Securities Act of 1933. Historically, individual investors who do not meet specific income or net worth tests have been denied many opportunities to invest in private equity transactions regardless of their financial sophistication. The amendments change the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in these markets.

The amendments revise Rule 501(a) as well as Rule 215 and Rule 144A of the Securities Act. The amendments to the accredited investor definition in Rule 501(a) are as follows:

Individuals Holding Certain Professional Certifications

A new category was added to the definition of accredited investor 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 SEC may designate from time to time by order. In conjunction with the adoption of the amendments, the SEC designated by order holders in good standing of the following licenses administered by the Financial Industry Regulatory Authority as qualifying natural persons: Series 7, Series 65 and Series 82. This approach provides the SEC with flexibility to reevaluate or add certifications, designations or credentials in the future.

Knowledgeable Employees

A new category was added to the definition of accredited investor for individuals to permit “knowledgeable employees” of a private fund to invest as accredited investors for investments in the fund. The amendments define “knowledgeable employee” to mean as such term is defined in Rule 3c-5(a)(4) of the Investment Company Act (ICA), which includes, among other persons: (a) an executive officer, director, trustee, general partner, advisory board member or person serving in a similar capacity, of the private fund or an affiliated management person (as defined in Rule 3c-5(a)(1) of the ICA) of the private fund and (b) an employee of the private fund or an affiliated management person of the private fund other than an employee performing solely clerical, secretarial or administrative functions with regard to such company or its investments who, in connection with such person’s regular functions or duties, participates in the investment activities of such private fund, other private funds or investment companies the investment activities of which are managed by such affiliated management person of the private fund, provided that such employee has been performing such functions and duties for or on behalf of the private fund or the affiliated management person of the private fund or substantially similar functions or duties for or on behalf of another company for at least 12 months.

Addition of Certain Entities

Limited liability companies with $5 million in assets that were not formed for the specific purpose of acquiring the securities being offered may be accredited investors, as may SEC- and state-registered investment advisers, exempt reporting advisers and rural business investment companies (RBICs).

A new catch-all category was added to the definition of accredited investor to allow any entity, including Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries, to qualify as an accredited investor if it owns “investments,” as defined in Rule 2a51-1(b) under the ICA, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.

Family Offices and Family Clients

The amendments add a new category to the definition of accredited investor for a “family office,” as defined in Rule 202(a)(11)(G)–1 under the Investment Advisers Act of 1940 (IAA). To qualify, the family office would need to satisfy the following requirements: (a) it must have assets under management in excess of $5,000,000, (b) it must not have been formed for the specific purpose of acquiring the securities offered and (c) its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.

In addition, “family clients,” as defined in Rule 202(a)(11)(G)–1 under the IAA, of a family office meeting the requirements outlined above may also qualify as accredited investors if their prospective investment in the issuer is directed by the family office.

Spousal Equivalents

The amendments amend the accredited investor definition to allow spousal equivalents to pool finances when calculating joint income under Rule 501(a)(6) and net worth under Rule 501(a)(5) in order to qualify as accredited investors.

Effective Date

The amendments and order become effective 60 days after publication in the Federal Register.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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