In an effort to expand investment opportunities in private companies, on August 26, 2020, the Securities and Exchange Commission adopted amendments to the definition of an “accredited investor.” The amendments expand the definition as it applies in the exemption from registration for private offerings set forth in Regulation D under the Securities Act. In terms of significance to the capital markets, the SEC estimated Regulation D accounted for $1.56 trillion raised in 2019.
With the exception of directors, executive officers, and general partners of the issuer, the prior definition of an accredited investor used only net worth and income thresholds to determine the financial sophistication of natural persons qualified as an accredited investor. The financial thresholds applicable to individual investors, which continue as the principal criteria, include individuals whose net worth exceeded $1 million and those with income in excess of $200,000 in each of the two most recent years. The amendments add additional categories of natural persons who qualify as an accredited investor even if they do not meet the net worth or income test, including
- Individuals with certain professional qualifications, and
- “Knowledgeable employees” of private funds that invest in the fund.
In addition, the SEC expanded the categories of accredited investors to include certain entities with investments in excess of $5 million. The new rule amendments are summarized below.
Addition of New Categories of Natural Persons
The SEC added a new category for natural persons to qualify as accredited investors based on certain professional credentials that demonstrate an individual’s background and understanding in the areas of securities and investing. The new categories include, when credentials are held in good standing:
- Licensed General Securities Representatives (Series 7),
- Licensed Investment Adviser Representatives (Series 65), and
- Licensed Private Securities Offerings Representatives (Series 82).
Such categories were designated by a separate SEC rule and the categories may be expanded through future SEC rulemaking.
Addition of Knowledgeable Employees of Private Funds
“Knowledgeable Employees of Private Funds” is defined in the Investment Company Act and includes, among others, directors, executive officers, general partners, trustees, and advisory board members, or persons serving in a similar capacity, as well as certain employees, of a private fund. Such persons now qualify as accredited investors for purposes of investing in the fund or other funds managed by their employer.
Addition of Qualified Entities
The amended rule expands the list of entities that may qualify as accredited investors and includes the following:
- Limited liability companies and any other types of entities that
- have investments in excess of $5 million, and
- were not formed for the purpose of acquiring the securities offered;
- SEC and state-registered investment advisers; and
- Rural business investment companies (RBIC’s).
This amendment adds entities that may have previously been excluded, such as tribes, labor unions, governmental bodies and funds, and entities organized under the laws of a foreign country.
Addition of Family Offices
The amended rule allows family offices with at least $5 million in assets under the management of a person who is financially sophisticated to qualify as accredited investors. This amendment permits family members and certain key employees of the family office, as well as certain charitable organizations and trusts, to be accredited investors.
Addition of Spousal Equivalents
The rule allows individuals to pool net worth and income from spousal equivalents, defined as a cohabitant occupying a relationship generally equivalent to that of a spouse, in determining whether financial thresholds under the definition of accredited investor are met. The securities being purchased need not be acquired jointly.
While limited in scope, the overall effect of the amendments is to permit more investors to participate in private offerings. The amendments also facilitate capital formation for private companies by expanding the pool of individuals and entities allowed to invest in securities that are not generally available to the public.
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The SEC release amending the definition of an accredited investor under Regulation D of the Securities Act of 1933 may be found here. The final rule is substantially similar to the rule proposed in December 2019 and was adopted after consideration by the SEC of more than 200 comment letters on the proposed rule. The final rule will become effective on December 8, 2020 which is 60 days after publication in the Federal Register.