The SEC Updates Definition of an Accredited Investor

The U.S. Securities and Exchange Commission (SEC) has adopted amendments to the definition of an “accredited investor,” effectively expanding who is eligible to invest in certain private capital. The updated definition does not affect anyone currently qualified as an accredited investor—if you were accredited before, you should still be accredited.

Background on Accredited Investors

Participation in investment opportunities offered under exemptions that do not have the disclosure, procedural, and investor protection requirements provided by registration under the Securities Act of 1933 is limited to “accredited investors,” a term defined in Rule 501(a) and also found in Rules 215 and 144A of the Securities Act.

According to the current definition, an accredited investor can be a person or entity that meets certain income, net worth, or total assets qualifications. Broadly, an accredited investor is a person who exceeds a certain income or net worth threshold. (See the SEC’s Accredited Investors bulletin from Jan. 31, 2019, for these thresholds and other applicable rules.)

The SEC has historically maintained that the accredited investor definition is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or fend for themselves render the protections of the Securities Act’s registration process unnecessary.” The amended definition is based on the belief that wealth should not be the sole means of establishing financial sophistication. An individual’s ability to analyze potential risks and rewards, to effectively allocate investments to mitigate undue risk, to access and understand information about an issuer or an investment opportunity, and to bear the risk of the loss are factors that the SEC felt should be incorporated.

New Amended Definition

According to the SEC’s Aug. 26, 2020, press release, “The amendments update and improve the definition [of an accredited investor] to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.”

The updated definition of an accredited investor expands the existing qualifications with amendments to revise Rules 501(a), 215, and 144A of the Securities Act. In general, the SEC will allow individuals to qualify as an accredited investor based on certain professional certifications, designations, or credentials, as well as “knowledgeable employees” of a private fund. Also, the income and net worth qualifications that apply jointly to an individual and his or her spouse is expanded to include a “spousal equivalent,” which is defined as a cohabitant with a relationship generally equivalent to that of a spouse.

Additionally, certain non-natural person entities (such as limited liability companies, Indian tribes and governmental bodies, and “family offices”) may now also qualify as accredited investors if they meet certain minimum asset qualifications described in the amendments.

In summary, the expansion includes the following as new qualifications for being an accredited investor:

  • Persons holding certain professional certifications, designations, or credentials
  • “Knowledgeable employees” of a private fund
  • Limited liability companies and certain other entities with $5 million minimum assets
  • Certain qualified entities, such as Indian tribes and governmental bodies, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million
  • “Family offices” with minimum $5 million in assets under management that meet certain requirements
  • “Spousal equivalents” allowed to pool finances for the purpose of qualifying as accredited investors under the rules for joint finances

With these new rules, the SEC states that the updates are meant to “simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.”

The amendments with these updated definitions of an accredited investor will become effective 60 days after publication in the Federal Register. For more details, you can review the SEC’s fact sheet and the Final Rule.

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What Is an Accredited Investor?

An accredited investor is an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities. They are entitled to this privileged access by satisfying at least one requirements regarding their income, net worth, asset size, governance status or professional experience.

In the U.S., the term accredited investor is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include natural high net worth individuals (HNWI), banks, insurance companies, brokers and trusts.

KEY TAKEAWAYS

  • Sellers of unregistered securities are only allowed to sell to accredited investors, who are deemed financially sophisticated enough to bear the risks. 
  • Accredited investors are allowed to buy and invest in unregistered securities as long as they satisfy one (or more) requirements regarding income, net worth, asset size, governance status or professional experience. 
  • Unregistered securities are considered inherently more risky because they lack the normal disclosures that come with SEC registration. 

Highlights from The New Sec Government Guidelines for Accredited Investors:

The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.

The amendments to the accredited investor definition in Rule 501(a):

  • add a new category to the definition 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 Commission may designate from time to time by order.  In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.  This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future.  Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
  • include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
  • clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
  • add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
  • add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
  • add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

The amendment to Rule 215 replaces the existing definition with a cross reference to the definition in Rule 501(a).

The amendments expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition.  The amendments also add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.

The Commission also adopted conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.

What’s Next?

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

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Sources:

https://www.sec.gov/news/press-release/2020-191 https://www.investopedia.com/terms/a/accreditedinvestor.asp https://microventures.com/sec-update-new-changes-to-regulation-crowdfunding-rule

https://www.investopedia.com/terms/a/accreditedinvestor.asp

https://www.investopedia.com/terms/a/accreditedinvestor.asp

https://www.investopedia.com/terms/a/accreditedinvestor.asp

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