Alerts

SEC Adopts Amendments to the Accredited Investor Definition

Alerts / August 31, 2020

On Aug. 26, 2020, the U.S. Securities and Exchange Commission (SEC or Commission) amended the definition of “accredited investor” by expanding the criteria by which individuals and entities can qualify as accredited investors. These changes are intended to expand participation in unregistered securities offerings and thus widen the pool of potential investors for companies. As explained by SEC Chairman Jay Clayton, “individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication.” The SEC anticipates that the amendments will improve access to capital, particularly for small and early‑stage businesses.

Background

According to the SEC, companies raised approximately $1.2 trillion in registered offerings in 2019 and an estimated $1.56 trillion in unregistered offerings under Rules 506(b) and 506(c) of Regulation D under the Securities Act of 1933 (Securities Act). As registered offerings are often too burdensome for many companies, exemptions from registration, and particularly the exemptions in Rules 506(b) and 506(c), are important for companies seeking to raise capital. The safe harbors offered by these rules are available to companies that comply with certain requirements, including restrictions on sales to persons who are not accredited investors. Private offerings pursuant to Rule 506(c) are limited to only accredited investors, and offerings under Rule 506(b) permit unlimited accredited investors and up to 35 nonaccredited investors to participate, provided that more comprehensive disclosures are provided to the nonaccredited investors. As we previously reported, the SEC considered revising the definition for years and requested comments on the definition in June 2019 as part of its concept release “Harmonization of Securities Offerings Exemptions.”

Summary of Final Amendments

The new amendments expand the definition of accredited investor by:

  • Including individuals who hold certain professional credentials designated by SEC order and who are in good standing (Series 7, Series 65 and Series 82 licenses are initially designated as qualifying);
  • Including “knowledgeable employees” (as defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940 (’40 Act)) of a fund exempt from the ’40 Act under Section 3(c)(1) or 3(c)(7) thereof, with respect to securities being offered or sold by such fund;
  • Expressly stating that limited liability companies with $5 million in assets are included;
  • Including SEC- and state-registered investment advisers, investment advisers exempt from registration pursuant to Section 203(l) or (m) of the Investment Advisers Act of 1940 (Investment Advisers Act), and Rural Business Investment Companies (as defined in Section 384A of the Consolidated Farm and Rural Development Act);
  • Including any entity that owns investments (as defined in Rule 2a51-1(b) under the ’40 Act) in excess of $5 million and that was not formed for the purpose of investing in the offered securities;
  • Including “family offices” (as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act) with at least $5 million in assets under management, that were not formed for the purpose of acquiring the securities, and whose investment is directed by someone with sufficient knowledge and experience, as well as “family clients” (also defined under the Investment Advisers Act) thereof;
  • Adding a definition of “spousal equivalent” and allowing an individual to calculate joint net worth or joint income with such person to qualify as an accredited investor; and
  • Clarifying that an entity can be an accredited investor if the individual owners (looking through intermediate entities) are all accredited investors.

To effectuate these changes, the SEC adopted amendments to Rule 144A, Rule 163B, Rule 215 and Rule 501 under the Securities Act, and Rule 15g-1 under the Securities Exchange Act of 1934. These amendments will become effective 60 days after they are published in the Federal Register.

Conclusion

Differences of opinion within the Commission remain as to whether these amended standards provide the appropriate balance of investor protection and expanded access to capital. Accordingly, we expect continued monitoring of the impact of the new accredited investor definition and consideration of further amendments to the financial sophistication criteria, among other aspects.

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If you are interested in learning more about these amendments, please contact Teresa Goody Guillén, Michael W. Moyer or your regular BakerHostetler representative.

Authorship Credit: Teresa Goody Guillén, Marisa T. Kirio, Emily R. Krisher, Michael W. Moyer and Michelle N. Tanney

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