SEC Proposes Amending the Definition of an "Accredited Investor"

On December 18, 2019, the Securities and Exchange Commission (“SEC”) proposed amendments to the definitions of an accredited investor under Rule 501(a) of Regulation D and of a qualified institutional buyer under Rule 144A(a)(1).

An “accredited investor” is an investor who may deal in securities that are not registered with financial regulatory bodies. Generally, an investor or entity would have to meet certain net worth or income thresholds to qualify as an “accredited investor.” The SEC previously believed that if one were to surpass these thresholds, they would be financially sophisticated enough to not need the traditional protections provided by regulatory disclosure filings. Accordingly, the accredited investor status provides additional investment opportunities that would not be available to traditional investors such as investing in hedge funds or Regulation D private placement offerings.

The definition of an accredited investor has been updated three times since it was passed in 1982, but the SEC no longer believes that wealth should be the sole means to determine an investor’s financial sophistication. Therefore, the SEC has proposed adding new categories that would allow individuals and entities to qualify as an accredited investor on the basis of ability to assess an investment opportunity irrespective of wealth. Additionally, the SEC has proposed to amend the definition of qualified institutional buyer to avoid inconsistencies between entities that are eligible for accredited investor status and those that are eligible for qualified institutional buyer status. The following is a summarized version of the SEC’s proposed additional categories.

Professional Certifications and Designations and Other Credentials

The SEC has identified a non-exhaustive list of attributes it would consider in determining which professional certifications and designations and other credentials would qualify an individual for accredited status. The attributes include (1) arising out of an examination or series of examinations administered by a self-regulatory organization, industry body or an accredited educational institution; (2) the examination is designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing; (3) persons obtaining the certification, designation or credential can reasonably be expected to have sufficient knowledge and experience in financial and business matters to sufficiently evaluate the Regulation D market; and (4) proof the individual holds the certification or designation is made publicly available by the issuing body. The SEC preliminarily expects that the Series 7, Series 65 and Series 82 licenses would qualify an individual to be an accredited investor.

Knowledgeable Employees of Private Funds

The SEC believes that knowledgeable employees, as defined under Rule 3c-5 of the Investment Company Act, through their knowledge and active participation of the investment activities of the private fund, are likely to be financially sophisticated and capable of fending for themselves in evaluating investments in such private funds. Therefore, the SEC’s definition of a knowledgeable employee would be the same in scope as Rule 3c-5(a)(4) and would include, among other people, trustees and advisory board members, or persons serving in a similar capacity, of a Section 3(c)(1) or 3(c)(7) fund or an affiliated person of the fund that oversees the fund’s investments, as well as employees of the private fund or the affiliated person 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 such private fund for at least 12 months.

Proposed Note to Rule 501(a)(5)

The SEC has proposed to clarify that the calculation of “joint net worth” for purposes of Rule 501(a)(5) can be the aggregate net worth of an investor and his or her spouse and that the securities being purchased need not be purchased jointly.

Registered Investment Advisors

The SEC has proposed to include Rule 501(a)(1) investment advisers registered under Section 203 of the Advisors Act and investment advisors registered under the laws of the various states because registered investment advisors appear to have the requisite financial sophistication needed to conduct meaningful investment analysis.

Rural Business Investment Companies

The SEC believes that since rural business investment companies (“RBICs”), as defined under Section 384A of the Consolidated Farm and Rural Development Act, have a similar purpose to small business investment companies, which are already included as accredited investors under Rule 501(a)(1), RBICs should also be included as accredited investors.

Limited Liability Companies

The SEC has proposed to codify a longstanding staff position that a limited liability company that meets the requirements of Rule 501(a)(3), including the assets test, should be considered to have the requisite financial sophistication to qualify as accredited investors.

Other Entities Meeting an Investments-Owned Test

The SEC believes that in the future a new corporate form could gain acceptance in the future that does not fit into the currently enumerated categories, and so long as the entity owns investments in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offer, that entity should be an accredited investor.

Proposed Note to Rule 501(a)(8)

The SEC has proposed to clarify that, in determining accredited investor status under Rule 501(a)(8), when one entity is an equity owner of another entity, one may look through various forms of equity ownership to natural persons. Thus, if those natural persons are accredited investors and all other equity owners of the entity are accredited investors, the entity is an accredited investor under Rule 501(a)(8).

Certain Family Officer and Family Clients

The SEC has proposed to allow family offices and its family clients, as defined in the family office rule, to be considered accredited investors so long as (1) the family office has at least $5 million in assets under management; (2) the purchases are directed by a person who has the knowledge and experience in financial and business matters that such family office is capable of evaluating the prospective investment; and (3) the family office was not formed for the specific purpose of acquiring the securities offered.

Permit Spousal Equivalents to Pool Finances for the Purposes of Qualifying as Accredited Investors

The SEC has proposed to clarify that natural persons are allowed to include joint income from spousal equivalents when calculating joint under Rule 501(a)(6) and to include spousal equivalents when determining net worth under Rule 501(a)(5), with spousal equivalent being defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.

Rule 215

The SEC has proposed to conform the definition of accredited investor found in Rule 215 to the amendments to the accredited investor definition of Rule 501(a) to ensure uniformity.

Rule 163B

The SEC has proposed to amend Rule 163B to include a reference to the proposed Rules 501(a)(9) and (a)(12) to maintain consistency between Rule 163B and Section 5(d).

Rule 15g-1

The SEC has proposed to amend Rule 15g-1 to include a reference to the proposed Rules 501(a)(9) and (a)(12) because like the institutional accredited investors currently within the scope of Rule 15g-1(b) as well as those that would become accredited investors under the newly proposed Rule 501(a)(1), entities owning over $5 million of investments that are not formed for the specific purpose of acquiring the securities being offered and family offices do not need the protections provided by Rules 15g-2 through 15g-6.

Rule 144A Qualified Institutional Buyer Definition

The SEC has proposed to make conforming changes to Rule 144A(a)(1)(i)(C) and the list of entities in Rule 144A(A)(1)(i)(H) to correspond to the proposed amendments to Rule 501(a)(1) and Rule 501(a)(3) to remove the inconsistencies between entity types eligible for accredited investor status and qualified institutional buyer status.