SEC Adopts Amendments to "Accredited Investor" Definition

The SEC recently adopted amendments to its long-standing "accredited investor" definition that determines which investors qualify for investment in private securities offerings conducted under Regulation D under the Securities Act of 1933 without the issuers having to comply with state and federal disclosure or registration requirements.

At a high level, the definitional changes broaden the categories of individuals and entities that qualify as accredited investors by adding categories of eligibility based on those investors’ professional knowledge, experience or certifications.  The definitional change also acknowledges societal changes in the 35+ years since the definition was first adopted by recognizing that “spousal equivalents” (i.e., domestic partners and similar relationships) are now common and permitting their assets and income to be pooled to enable accredited investor qualification.  The stated purpose of the amendments is to “update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.” Thus, individuals and entities may now qualify as accredited investors based not only on income or net worth, including that of non-traditional families, but also based on defined measures of financial sophistication.

Primary changes
Investors who meet the following criteria will now qualify as accredited investors under the amended definition:

• Holders of certain professional licenses which are deemed to demonstrate relevant professional knowledge. Initially this will include persons who hold Series 7, Series 65 and Series 82 licenses.  The SEC has reserved the authority to periodically add categories to this list.
• Limited liability companies with at least $5 million in assets.  Currently, partnerships, 501(c)(3) organizations, business trusts and corporations qualify for accredited investor status if they have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered. The amendment adds limited liability companies to this list in recognition of the growing role they play in company formations.
• SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies.  Exempt reporting advisers are considered "registered" for purposes of the newly changed definition.
• Any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
• “Family offices” with at least $5 million in assets under management and their “family clients.” Family Offices are entities established by families to manage their assets, plan for their families' financial future, and provide other services to family members. Family Clients generally are family members, former family members, and certain key employees of the family office, as well as certain of their charitable organizations trusts, and other types of entities. Both of these definitions largely mirror their counterparts in the Investment Advisers Act of 1940.
• For investment in a private fund, “knowledgeable employees” of the private fund.  These will include the fund’s executive officers, directors, trustees, general partners and advisory board members, as well as persons serving in a similar capacity of the fund or an affiliated management person of the fund.
  

Qualification Through Owner Status.  Currently, an entity can qualify as an accredited investor if all of its owners are accredited investors. In some cases the entity seeking to be an accredited investor is owned by another entity. The SEC has added language clarifying that for purposes of this test all of the entities in the chain may be looked through to the ultimate owners to determine accredited investor status.

Spousal equivalent. Under the adopted rule, a natural person, together with a spouse, may qualify as an accredited investor by either having 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 both the income and net worth criteria to include “spousal equivalents.” The SEC views a Spousal Equivalent as a cohabitant occupying a relationship generally equivalent to that of a spouse.

Practical considerations

The amendments will become effective 60 days following formal publication in the Federal Register, which means the rules will likely start to apply to new offerings in December 2020 or January 2021.