Broadening Definition of "Accredited Investor" Expands Sources of Capital for Growing Companies

OVERVIEW

On August 26, 2020, the U.S. Securities and Exchange Commission (the "SEC") issued a final rule changing the definition of "accredited investor." Accredited investors have access to private, unregistered capital offerings, based on the assumption that their status means that such investors have the sophistication and means to participate in high-risk private offering transactions. The final rule expands the definition of accredited investor in Rule 501 of Regulation D.

The definition of accredited investor had not been updated since 1982.  The amendments maintain the current criteria for an accredited investor and expand it, potentially increasing the pool of accredited investors, adding the following two new qualifications for natural persons to satisfy the definition of an accredited investor:

• An individual who possesses certain professional credentials, demonstrating a background and understanding in securities and investments. Although the rule does not specify which credentials apply, the SEC's issuing order states that holders in good standing of a Series 7, 65, or 82 license are accredited investors.

• Knowledgeable employees of private funds. For purposes of the rule, “knowledgeable employees” include trustees, advisory board members, as well as employees of the private fund whose regular job functions or duties for at least 12 months include participating in the fund's investment activities.

For determining if a natural person qualifies as an accredited investor, an individual investor may pool finances with a "spousal equivalent", which is defined as a cohabitant who occupies a relationship generally equivalent to a spouse.

In addition to expanding the criteria for natural persons, the final rule expands several categories of entities that qualify as accredited investors: 

• SEC- and state-registered investment advisers;

• Exempt reporting advisers;

• Rural business investment companies (RBICs);
• Limited liability companies that have total assets in excess of $5 million, as well as other entities owning investments in excess of $5 million, which were not formed for the specific purpose of acquiring the securities being offered; and
• "Family offices" and "family clients of family offices" that have a minimum of $5 million of assets under management and have not been formed for the specific purpose of acquiring the securities being offered.

The final rule clarifies that an entity will qualify as an accredited investor if all of its equity holders are accredited investors, adding a note allowing issuers to look through layers of ownership to evaluate whether the natural person behind the investing entity would satisfy the accredited investor criteria.

The final rule also makes certain changes to the definition of qualified institutional buyers, for purposes of satisfying the safe harbor exemption from registration under Rule 144A. The final rule expands the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the threshold amount of $100 million in securities owned and invested.  Institutional investors that satisfy the $100 million threshold are now included in the accredited investor definition even if not otherwise a “qualified institutional buyer.”

CONCLUSION

These changes will be effective 60 days after publication in the Federal Register, which has yet to occur.