The SEC Expands the Definition of Accredited Investor

September 2, 2020

I. Introduction

On August 26, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to Rule 501(a) under the Securities Act of 1933 (the “Securities Act”), which defines the term “accredited investor” for purposes of the Regulation D “safe harbor” thereunder (the “Amended Rule”). Under the Amended Rule, a natural person will be an accredited investor based on his or her: (i) professional certifications or designations; (ii) credentials from an accredited educational institution; or (iii) status as a private fund’s “knowledgeable employee”. A natural person will also be able to aggregate his or her income or net worth with that of the person’s “spousal equivalent” in determining whether it meets financial thresholds set forth in the current accredited investor definition.¹ The Amended Rule also adds “family offices” and their respective “family clients” as new categories of accredited investors, provided that they meet certain requirements. In addition, an entity’s status as an SEC-registered investment adviser, a state-registered investment adviser, an exempt reporting adviser or a rural business investment company will make it an accredited investor under the Amended Rule. The Amended Rule also adds a “catch-all” entity category intended to capture all entity types not currently included in the current accredited investor definition, as well as those that may be created in the future, provided that any such entity satisfies an “investments” test and was not formed for the specific purpose of acquiring the securities offered. The SEC also adopted amendments to other securities law rules that referenced the current accredited investor definition in Regulation D to conform those rules to the Amended Rule.

II. Amendments to Accredited Investor Definition

A. Natural Persons

Under the current accredited investor definition, with the exception of certain individuals affiliated with the issuer making the securities offering², a natural person is required to satisfy a net worth test³ or an income test⁴ to be an accredited investor. The Amended Rule adds the following two categories of natural person accredited investors.

(1) Natural Persons Holding Professional Certifications and Designations or Other Credentials

Under the Amended Rule, “any natural person holding in good standing one or more certifications or designations or credentials from an accredited educational institution that the Commission has designated as qualifying an individual for accredited investor status” will be an accredited investor.⁵ In connection with adopting the Amended Rule, the SEC issued an order designating the following as its initial certifications, designations and credentials for these purposes: (i) the General Securities Representative license (Series 7); (ii) the Private Securities Offerings Representative license (Series 82); and (iii) the Licensed Investment Adviser Representative (Series 65). To comply with the “good standing” requirement, the individual must pass the required examination and maintain his or her license or registration, as applicable, in good standing.

(2) Knowledgeable Employees of Private Funds

Pursuant to the Amended Rule, any natural person who is a “knowledgeable employee” of a private fund⁶ offering or selling its securities will be an accredited investor in respect of his or her investments in that private fund.

Addition of the Term “Spousal Equivalent” to the Accredited Investor Definition

Under the current accredited investor definition, a natural person is permitted to aggregate his or her net worth or income, as applicable, with that of the person’s spouse in determining whether it satisfies the financial thresholds set forth in the Rule 501(a)(5) net worth test or the Rule 501(a)(6) income test. The Amended Rule permits a natural person to aggregate his or her net worth or income, as applicable, with that of the person’s “spousal equivalent” in determining whether it satisfies either of those tests.⁷ The term “spousal equivalent” is defined in the Amended Rule as a “cohabitant occupying a relationship generally equivalent to that of a spouse”.

B. Family Offices and Family Clients

The Amended Rule also adds “family offices” and their respective “family clients”⁸, as those terms are defined under the Investment Advisers Act of 1940 (the “Advisers Act”), as new categories of accredited investors, provided that they meet certain requirements described below.

Family Offices

Under the Amended Rule, a family office is an accredited investor if: (i) it has assets under management in excess of $5 million; (ii) it was not formed for the specific purpose of acquiring the securities offered; and (iii) its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that the family office is capable of evaluating the merits and risks of the prospective investment.

Family Clients

Under the Amended Rule, a family client is also an accredited investor if the family client is: (i) a family client of a family office that is an accredited investor; and (ii) its prospective investment in the issuer is directed by a person at the family office for which it is a family client who has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the prospective investment.

C. Entities

The Amended Rule expands the existing list of entities that meet the definition of an accredited investor.⁹

SEC-Registered Investment Advisers, State-Registered Investment Advisers, Exempt Reporting Advisers and Rural Business Investment Companies

Under the Amended Rule, the following categories of entities are accredited investors under Rule 501(a)(1) solely as a result of their respective statuses: (i) SEC-registered investment advisers (including those that are sole proprietorships); (ii) state-registered investment advisers; (iii) exempt reporting advisers¹⁰; and (iv) rural business investment companies.¹¹

Limited Liability Companies

The Amended Rule also codifies a longstanding SEC staff position¹² that a limited liability company is an accredited investor if it: (i) has total assets in excess of $5 million; and (ii) was not formed for the purpose of acquiring the securities offered.

“Catch-All” Entity Category

The Amended Rule adds a “catch-all category” intended to capture all types of entities not currently included in the accredited investor definition, as well as entity types that may be created in the future. Specifically, any entity will be an accredited investor if it: (i) owns “investments”¹³ in excess of $5 million; and (ii) was not formed for the specific purpose of acquiring the securities offered.

III. Amendments to Other Securities Law Rules

The SEC also adopted amendments to several other securities law rules that referenced the current accredited investor definition to conform those other rules to the Amended Rule. In particular, the SEC adopted amendments to Rule 144A under the Securities Act¹⁴ to ensure that any entity that is an accredited investor under the Amended Rule is also a qualified institutional buyer (“QIB”) under Rule 144A to the extent such entity meets the $100 million in securities owned and invested threshold in Rule 144A(a)(1)(i).¹⁵ Rule 215 under the Securities Act, which is applicable to securities offerings made under Section 4(a)(5) of the Securities Act, was also amended to replace the existing accredited definition therein with a cross-reference to the Amended Rule to ensure that the accredited investor definition in both provisions is uniform. Moreover, Rule 163B under the Securities Act¹⁶ was amended to permit issuers to engage in test-the-waters communications with all entities that are accredited investors under the Amended Rule. Finally, Rule 15g-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), which exempts certain transactions by broker-dealers from disclosure requirements set forth in Rules 15g-2 through 15g-6 of the Exchange Act¹⁷ if the customer is an entity accredited investor, was amended to include all entity customers that are accredited investors under the Amended Rule.

* * * * * * *

The Amended Rule will become effective 60 days after its publication in the Federal Register (the “Effective Date”). Accordingly, investment managers should consider updating the subscription agreements of their private fund clients that issue their securities utilizing Regulation D to reflect the expanded accredited investor definition on the Effective Date. If you have any questions concerning the foregoing, please contact your primary attorney in Seward & Kissel’s Investment Management Group.

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¹ The Amended Rule did not change the dollar amounts of financial thresholds set forth in the current accredited investor definition.

² Under Rule 501(a)(4) of Regulation D, any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer is an accredited investor.

³ Under the current Rule 501(a)(5) of Regulation D, any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000 is an accredited investor. Rule 501(a)(5) also contains provisions relating to the calculation of net worth under the rule.

⁴ Under the current Rule 501(a)(6) of Regulation D, any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year is an accredited investor.

⁵ The Amended Rule also provides that, in determining whether to designate a professional certification or designation or credential from an accredited educational institution for purposes of such rule, the SEC will consider, among others, the following attributes: (i) whether the certification, designation, or credential arises out of an examination or series of examinations administered by a self-regulatory organization or other industry body or is issued by an accredited educational institution; (ii) whether the examination or series of examinations is designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing; (iii) whether persons obtaining such certification, designation, or credential can reasonably be expected to have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment; and (iv) an indication that an individual holds the certification or designation is either made publicly available by the relevant self-regulatory organization or other industry body or is otherwise independently verifiable. A note set forth in the Amended Rule provides that the SEC will designate such professional certifications, designations or credentials by order, after notice and an opportunity for public comment.

⁶ Rule 3c-5(a)(4) under the Investment Company Act of 1940 (the “Investment Company Act”) defines a “knowledgeable employee” with respect to a “private fund” (as defined below) as: (i) 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) under the Investment Company Act) of the private fund; and (ii) 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 his or her 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. A “private fund” is an issuer that would be an investment company, as defined in Section 3 under the Investment Company Act, but for the exclusion from the definition of “investment company” in Section 3(c)(1) or Section 3(c)(7) under the Investment Company Act.

⁷ The Amended Rule also contains a note to codify a previous SEC staff interpretation that reliance on the joint net worth standard in Rule 501(a)(5) does not require that the securities be purchased jointly. The note also confirms that assets need not be held jointly to be included in the joint net worth calculation.

⁸ The terms “family office” and “family client” are defined in Advisers Act Rule 202(a)(11)(G)-1.

⁹ A note was also added to Rule 501(a)(8). Under Rule 501(a)(8), an entity is an accredited investor if all of its equity owners are accredited investors. Since in certain instances an equity owner of an entity is another entity, the note clarifies that, in determining accredited investor status under Rule 501(a)(8), one may look through various forms of equity ownership to natural persons. Thus, if those natural persons are themselves accredited investors, and if all other equity owners of the entity are accredited investors, the entity is an accredited investor under Rule 501(a)(8).

¹⁰ An “exempt reporting adviser” is an investment adviser that qualifies for the exemption from registration under Section 203(l) of the Advisers Act because it is an adviser solely to one or more venture capital funds, or under Rule 203(m)-1 of the Advisers Act because it is an adviser solely to private funds and has assets under management in the United States of less than $150 million.

¹¹ A “rural business development company” is defined in Section 384A of the Consolidated Farm and Rural Development Act as a company that is approved by the Secretary of Agriculture and that has entered into a participation agreement with the Secretary.

¹² See Division of Corporation Finance interpretive letter to Wolf, Block, Schorr and Solis-Cohen (Dec. 11, 1996); and question number 255.05 of Securities Act Rules Compliance and Disclosure Interpretations, available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.

¹³ A note set forth in the Amended Rule provides that the term “investments” has the meaning set forth in Rule 2a51-1(b) under the Investment Company Act.

¹⁴ A QIB is an entity that is eligible to participate in resales of securities made under Rule 144A.

¹⁵ Rule 144A(a)(1)(i) specifies each entity type that is eligible for QIB status if, acting for its own account or the accounts of other QIBs, in the aggregate owns and invests on a discretionary basis at least $100 million in securities of unaffiliated issuers.

¹⁶ Pursuant to Securities Act Rule 163B, issuers may engage in test-the-waters communications with potential investors that are QIBs or institutions that are accredited investors to gauge their interest in a contemplated securities offering.

¹⁷ Rules 15g-2 through 15g-6 of the Exchange Act permit broker-dealers to disclose certain specified information to their customers prior to effecting a transaction in a “penny stock”, as such term is defined in Rule 3a51-1 of the Exchange Act.

The SEC Expands the Definition of Accredited Investor

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