SEC Amends Definitions of "Accredited Investor" and "Qualified Institutional Buyer"
The Securities and Exchange Commission has adopted amendments to its current rules under the Securities Act of 1933 relating to the definitions of an "accredited investor" and a "qualified institutional buyer." The amendments modify the definition for an accredited investor to include new categories of qualifying natural persons and entities and for a qualified institutional buyer to include some of the same entities that meet the other requirements of Rule 144A.
According to the SEC, the amendments are "intended to update and improve the definition to identify more effectively investors that have sufficient knowledge and expertise to participate in investment opportunities that do not have the rigorous disclosure and procedural requirements, and related investor protections."
What You Need to Know
The amendments adopted are substantially the same as the SEC’s prior proposals - for more information on such proposals see our prior Client Alert. The amendments will be effective in early November.
These amendments broaden the categories of investors to whom certain private offerings of securities, including offerings by operating companies, hedge funds, private equity funds, venture capital funds, angel funds, and private real estate funds, may be made.
Changes to Accredited Investor Definition
The amendments to Rule 501(a) (and Rule 215, which will now simply cross reference to Rule 501(a)) update and expand the definition of an accredited investor in the following ways:
- New Rule 501(a)(10) – Natural persons holding in good standing certain "professional certifications or designations or credentials" designated by order of the SEC will now qualify as accredited investors. Rule 501(a)(10) sets forth certain attributes which the SEC will consider when designating such certification, designation or credentials under this subsection.
- Series 7, Series 65 and Series 82, all administered by FINRA, are being designated, by separate order, by the SEC as the initial approved certifications or designations.
- The holder’s certification or designation must be active and in good standing. However, the holder need not practice in the field relating to the certification or designation.
- New Rule 501(a)(11) – Natural persons who are "knowledgeable employees," as defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940, of a private fund will now qualify as accredited investors for the offer or sale of such private fund’s securities. Private funds are those that would qualify as an investment company, as defined in Section 3 of the Investment Company Act, but for the exclusion provided under either Section 3(c)(1) or 3(c)(7).
- A new note under Rule 501(a)(8) makes clear that a private fund, particularly those with $5 million or less of assets (thus failing to qualify under Rule 501(a)(3)), may qualify as an accredited investor if all of the fund’s equity owners, both natural persons and otherwise, are accredited investors.
Prior to the adoption of the amendments the SEC’s definition of an accredited investor used wealth as a "proxy" for financial sophistication. In adopting the amendments, the SEC stated that the "characteristics of an investor contemplated by the [accredited investor] definition can be demonstrated in a variety of ways… includ[ing] the ability to assess an investment opportunity—which includes the ability to analyze the risks and rewards, the capacity to allocate investments in such a way as to mitigate or avoid risks of unsustainable loss, or the ability to gain access to information about an issuer or about an investment opportunity—or the ability to bear the risk of a loss."
Additionally, the SEC welcomes other accredited educational institutions, self-regulatory organizations, industry bodies or the general public to submit other certifications or designations, including specific degrees or programs of study, that meet the attributes enumerated in Rule 501(a)(10) for the SEC to consider including in the accredited investor definition.
- Amended Rule 501(a)(1) – Investment advisors registered under Section 203 of the Investment Advisers Act of 1940 or registered under the laws of various states and exempt investment advisers, qualifying for an exemption under Section 203(m) or 203(l) of the Investment Advisers Act, will now qualify as accredited investors.
- Amended Rule 501(a)(1) – Rural Business Investment Companies, as defined in Section 384A of the Consolidated Farm and Rural Development Act (companies that are approved by the Secretary of Agriculture and have entered into a participation agreement with the Secretary), will now qualify as accredited investors.
- Amended Rule 501(a)(3) – Though previously informally permitted, limited liability companies, along with the other entity types previously listed in Rule 501(a)(3), with total assets in excess of $5 million will now explicitly qualify as accredited investors as long as they are not formed for the specific purpose of acquiring the securities offered.
- New Rule 501(a)(9) – Entities that do not qualify under other sections of Rule 501(a) that own "investments" (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million, not formed for the specific purpose of acquiring the securities offered, will now qualify as an accredited investor.
- Rule 501(a)(9) will act as a catch all and encompass Indian tribes, governmental bodies, and funds or entities organized under the laws of a foreign country.
- New Rule 501(a)(12) & (13) – A "family office," as defined in Rule 202(a)(11)(G)-1 of the Investment Advisers Act, with (i) assets under management in excess of $5 million, (ii) that is not formed for the specific purpose of acquiring the securities offered and (iii) whose prospective investment is directed by a person who has the knowledge and experience capable of evaluating the merits and risks of the prospective investment will now qualify as an accredited investor. Additionally, "family clients," as defined in Rule 202(a)(11)(G)-1 of the Investment Advisers Act, of a qualifying family office whose prospective investment is directed by such family office will now qualify as an accredited investor.
The term "spousal equivalent" has been added to Rule 501(a)(5) and (6) to allow natural persons to include their spouses or spousal equivalents when calculating joint income or joint net worth. Spousal equivalent is defined as "a cohabitant occupying a relationship generally equivalent to that of a spouse." This definition matches that of the definition used elsewhere by the SEC in Regulation Crowdfunding and the Jumpstart Our Business Startups (JOBS) Act.
A new note under Rule 501(a)(5) makes clear a long-standing staff interpretation that assets for the joint net worth test do not need to be held jointly; nor do the securities need to be purchased jointly.
Changes to Qualified Institutional Buyer Definition
The amendments to Rule 144A expand the definition of qualified institutional buyer in much the same way as the accredited investor definition was expanded, including:
- Amended Rule 144A(a)(1)(i)(C) – Rural Business Investment Companies, as defined in Section 384A of the Consolidated Farm and Rural Development Act, can now qualify as qualified institutional buyers.
- Amended Rule 144A(a)(1)(i)(H) – Limited liability companies, along with the other entity types previously listed in Rule 144A(a)(1)(i)(H) and excluding certain entities previously excluded therein, can now qualify as qualified institutional buyers if they meet the other requirements of the subsection.
- New 144A(a)(1)(i)(J) – Institutional accredited investors under Rule 501(a), of an entity type not already included in paragraphs 144A(a)(1)(i)(A) through (I) or 144A(a)(1)(ii) through (vi), can now qualify as qualified institutional buyers when they satisfy the $100 million threshold. The SEC noted that, although a strict reading of the new Rule 144A(a)(1)(i)(J) might import the “not formed for the specific purpose of acquiring the securities offered” provision of Rule 501(a), an entity seeking qualified institutional buyer status under this rule may be formed for the purpose of acquiring the securities being offered under this section.
- Includes Indian tribes, governmental bodies and bank-maintained collective investment trusts.
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If you would like further information regarding the above referenced amendments or their impact, please contact the lawyer at Sullivan with whom you regularly consult or either of the lawyers listed above.