The SEC Amends the Definition of “Accredited Investor” and the Debate Over Private Market Protections Continues
On August 26, 2020, the Securities and Exchange Commission amended Rule 501(a) of the Securities Act of 1933, expanding the definition of “accredited investor,” which is one of the principal tests for determining who is eligible to participate in private capital markets in the United States.[1] The SEC additionally amended Rules 144A, 215, and 163B of the Securities Act and Rule 15g-1 under the Securities Exchange Act of 1934 essentially to include the new categories of accredited investors.[2] The amendments are effective 60 days after publication in the Federal Register.
In very general summary, the SEC expanded the definition of “accredited investor” to include for example new categories of natural persons who meet professional certification or status requirements (in other words, a knowledge based test rather than an asset based test) and new types of entities, including entities owning $5 million in investments and family offices with at least $5 million in assets under management. According to the SEC’s press release accompanying the Final Rule, the amendments “allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”
As those in compliance in the private fund space know, the industry contends with multiple and often overlapping definitions applicable to any one fund and/or the investors in the fund, including for example, accredited investor, qualified client, and qualified purchaser. The SEC stated that the amendments “are part of the Commission’s ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investment protections and promoting capital markets.”
Advisers and private funds can continue to establish their own minimum qualifications for each fund, provided the qualifications are no less than is required by law, and it remains to be seen how many and how soon advisers might begin adding investors who previously would not have qualified as “accredited.”
Among other considerations, compliance teams may want to update references to “accredited investor” definitions in applicable policies and procedures, other compliance documents, and fund documents; and check to see if any investor onboarding protocols can or should be changed. Please let us know if you would like some assistance with these updates.
Addressing the larger context for a moment, the amendments reportedly will increase a business’s ability to raise capital as many companies limit their offerings to accredited investors, because, generally, there is a limit to how many non-accredited investors can participate, and the issuer’s disclosure obligations to those non-accredited investors are at times different and sometimes considered more burdensome. Said another way, additional investors now will have access to private companies that prior to the amendments were off-limits. The push for the amendments has been brewing, in particular following the Jumpstart Our Business Startups (JOBS) Act in 2012. Additionally, per the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC must review at least once every four years the definition of “accredited investor” as it relates to natural persons.
For those interested in the policy choices behind the decision, glimpses can be found in the Final Rule Release. There also is a Joint Statement issued by the two Commissioners who opposed the final decision, largely for failing to adequately protect investors (and in particular senior, also often known as “vulnerable,” investors) by not indexing to inflation, for example.
In issuing the Joint Statement, the two Commissioners revealed their concern that “there is a great deal we simply do not know about how the private market functions: (1) “We don’t know how many investors participate in these offerings.” (2) “We can’t distinguish individual investors who participate in such offerings from institutions.” (3) “We don’t know how much they invest or how they fare.” (4) “We can’t say with confidence how many private offerings even take place.” And, (5) We don’t know how many investors will be newly eligible for private offerings under these amendments.”
The dissenting Commissioners attributed much of these knowledge deficiencies to the lack of information in Form D filings. So, perhaps we will see changes to the Form D in the future. As the two said, the Commission had previously “put out a rule proposal aimed in part at enhancing our visibility into private offerings claiming exemptions from registration pursuant to Regulation D,” but the Commission never completed that rulemaking.
Whether or not additional regulatory disclosure obligations such as a more robust Form D are on the horizon, we in regulatory compliance encourage private fund issuers and advisers to be accurate and thorough with their existing disclosure obligations and investor communications in general. We are here to assist. If you have any questions or would like to speak to one of our regulatory experts, please email info@cssregtech.com.
[1] Rule 501 is part of the Regulation D network of rules that govern the limited offer and sale of securities without registration under the Securities Act of 1933. Regulation D provides an exemption for the transactions in which the securities are offered or sold by the issuer (not for the securities themselves). Rule 501(a) defines who or what is an “accredited investor” at the time of the sale of the securities to that person. Issuers can readily meet public offering exemption conditions by selling only to purchasers who are “accredited investors.” (See for example, 506(b).)
[2] Rule 215 defines “accredited investors” as used for purposes of Section 4(a)(5), which exempts non-public offers and sales of up to $5 million made solely to accredited investors (with no general solicitation or general advertising). By amending Rule 215, the SEC harmonized the definition of accredited investor as utilized in both Rule 501 for Regulation D and Rule 215 for Section 4(a)(5).
Rule 163B references “institutional accredited investors” as one category of persons to whom an issuer may communicate regarding certain securities offerings.
Rule 15g-1 provides a list of transactions that can be exempt from certain penny stock requirements and includes transactions in which the customer is an “institutional accredited investor.”
The amendments also expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs provided they meet the $100 million in securities owned and invested threshold in the definition. Rule 144A provides an exemption from registration for resales of certain securities to qualified institutional buyers. The amendments also add any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer” again provided they satisfy the $100 million threshold.
Gaining a Seat at the Table – Influencing from Within
Throughout my career, I’ve never heard a business leader say compliance isn’t important. Time and again, through countless conversations and interviews, compliance is touted as paramount to the firm. And while those presidents and CEOs may think they believe that, often compliance is left out of those key meetings and decisions, only being filled in later to “make it happen.” If you have “compliance” in your title, likely this has happened to you. So how can you keep this from happening?
Earning Confidence
If you expect to get an invite to the meeting simply because of your title or status at the firm, I suspect you’re in for a rude awakening. When conversations come up about a new offering, the goal is to have people think, “Let’s get Compliance involved early so we go down the right path.” No one likes to have an idea gain momentum only to have it change course (or worse, squashed) later on. That’s uncomfortable on both sides of the table.
In order to be a part of those discussions, you have to prove you’ll add value. So how does compliance show its value when it’s typically viewed as the “No” department?
First, be a student of the firm. This is easy when you are new and trying to gain a fundamental understanding of what exactly the company does. But beyond those initial meetings with departments, dig deeper. Ask questions that are not directly tied to regulatory considerations.
Ask questions like:
- What’s our main product line? How is the firm’s overall revenue tied to the various offerings?
- How do we define our target market? How has that evolved and are there any plans to change this?
- What systems do we use? How do they tie in with each other? Can I see what kinds of reports and data we can get out of them?
Showing that you’re interested in things beyond your day-to-day responsibilities shows a genuine concern for the overall success of the company. It also helps you piece things together for your own understanding and will ultimately make it easier to get things accomplished.
Demonstrating Value
Once you’ve earned the seat at the table, how do you keep it? It’s no surprise that most measures of success are quantifiable. Firms often set out high-level goals – so how can you tie your efforts into the firm’s successes?
You have to understand what the goals are. I know this seems obvious, but as you’re reading this now, can you recite your firm’s goals for this year? What about the 3- and 5-year goals?
Don’t let yourself become just an email address. Just as it’s important to get to know people on a more personal level, let them also get to know you. Communications (and compliance) goes both ways.
To read the full chapter Gaining a Seat at the Table – Influencing from Within, download The CCO’s Playbook.
Navigating Regulatory Change: How to Win the Regulatory Game
Being a Chief Compliance Officer navigating regulatory change is a lot like quarterbacking an offense in an action-packed (American) football game: you’re responsible for calling the plays, reading the opposition, seeing opportunity, and leading the team to victory. This can really be applied to any sport or business. With the expanding scope of regulations demanding constant improvement and agility, how do compliance teams anticipate change and win the regulatory game?
Stay Apprised of Rulemaking
In order to read the opposition, you’ve got to watch film on the opponent.
Make it a point to devote time every day to stay on top of industry news and new regulations. Sounds easy, but Compliance Officers get pulled in so many different directions and finding the extra time can be challenging. Staying apprised of what is on the regulators’ agenda can put you and the firm in a position of being proactive rather than reactive when a new rule comes down the pipeline.
Spend the first 30 minutes of your day having your “Coffee and Regs”
- Make it a point to devote time every day to stay on top of industry news and new regulations. Sounds easy, but CCOs get pulled in so many different directions and finding the extra time can be challenging. Staying apprised of what’s on the regulators’ agenda can put you and the firm in a position of being proactive rather than reactive when a new rule comes down the pipeline.
- Subscribe to bulletins from law firms and compliance consulting firms, read Investment News, and listen to podcasts (like CSS’s Coffee & Regs!)
- Consider joining industry associations, such as the Investment Advisers Association and the Financial Services Institute. These groups engage with legislators and regulators to help shape regulation and affect change, and are a great resource for regulatory updates.
- Attend industry conferences and network with other compliance professionals. Conferences provide the opportunity to learn about best practices and hear from your peers on how they are navigating new requirements.
Educate Members of Your Firm on the Impact of Changes
Team captains don’t win games alone; they’ve got a team behind them helping them to victory.
Once the regulators propose a new rule or regulation, educating others within your organization on the impact of the rule is a key part of the process. Engage other people in your organization and give them ownership of compliance. Not only can this lead to more effective implementation of new rules, but it can also help the firm with risk prevention. Call a meeting with other department heads, tell them the latest challenge, and ask them how the firm is going to tackle it. By taking a team approach, you may get some really creative solutions from other people in the organization as to how the firm can implement the rule changes.
Incorporate Regulatory Changes into Your Compliance Program
See the opportunity and create a strategic offense.
The process of implementing regulatory changes is a great opportunity for CCOs to show their value to the business. Support business growth by taking a business-friendly approach when responding to regulatory changes. Get creative and bring ideas to the table! Studies have shown that people are the greatest challenge to implementing change. Effectively incorporating regulatory changes into your compliance program requires the business to embrace a culture of proactive compliance and risk management.
To read the full chapter Navigating Regulatory Change: How to Win the Regulatory Game, download The CCO’s Playbook.
The Lasting Impact of COVID-19 on Investment Management
The COVID-19 pandemic and related shutdown of global economies will be remembered as one of the most significant shocks to the investment management industry.
In early 2020, global economies were generally strong. By mid-March, the U.S. was in a full-blown credit crisis, with credit markets seizing, buyers were avoiding even “safe” investments like U.S. Treasuries and investors were fleeing money market funds. On March 16, the Dow Jones Industrial Average suffered its second worst day in its history. Governments around the world stepped in to provide massive amounts of liquidity to stabilize markets.
What are the Implications?
As with any major disruptive market event, there are meaningful impacts to investment managers resulting in lasting changes. Looking ahead, we see changes to how work is done, the rise of market volatility and an expected regulatory response. Each of these implications will increase complexity and challenge a firm’s compliance staff.
How Work is Done
The deployment of people and resources to “work from home” was largely successful throughout the global investment management industry. The rise of improved connectivity, Web-based telephone and video services and collaboration tools shattered long-held views on what types of work could be performed remotely. Employees in a wide-range of functions were able to access their work and stay productive. 2020 will be the year that “Zoom” became a verb and household pets joined in meetings. The flexibility unlocked by all these tools makes it clear that remote work is here to stay and available to a wider variety of jobs than previously imagined.
Market Volatility
Investment managers have been increasingly challenged with downward fee pressure over the past few years. The rise of ETFs and other passive investments and the democratization of information have led to steady decreases in fee rates. The increase in market volatility and the “instant” global recession create additional revenue pressures for investment managers. Throughout the spring and summer of 2020, 4-5% moves in the S&P 500 index were all too common. While the liquidity crunch of mid-March was eased with massive amounts of government intervention, the increased uncertainty weighs heavy on budget decisions.
As a result, investment managers are focusing more heavily on their expense line. While well-run firms understand the importance of effective compliance programs, spending constraints will challenge compliance teams to do more with less.
Regulatory Response
When the market goes to the brink of collapse and needs a massive amount of government support to bring stability, the regulatory framework is sure to be reviewed. In the immediate aftermath of the crisis, regulators have taken an active exam posture, reviewing for compliance while also gathering information as to how investment managers reacted to the crisis. If past crises are an indication, this is often followed by new rules designed to shore up the financial system from future shocks. In the coming months, we will need to pay attention to regulators around the globe for signals of future reforms.
To read the full chapter the Lasting Impact of COVID-19 on Investment Management, download The CCO’s Playbook.
Business Continuity and Preparing for Regulatory Exams Post-Pandemic
As a compliance professional, the past months have probably been the most challenging of your career. Events, whether COVID-19, significant market fluctuations, halted stock exchange trading, or liquidity concerns, provided new and unique challenges for even a seasoned compliance professional. And while the focus on these new risks should take center stage for compliance officers, there are other factors that should be addressed. Let’s first consider how your Business Continuity Plan (BCP) fared.
Starting in March 2020, investment managers experienced a true test of their BCP. Prior to March 2020, there were not many financial services firms that considered pandemic planning in their BCPs. Within a few short weeks, investment managers were forced to fully implement their continuity plans and figure out new ways to manage certain aspects of their business remotely. So, what worked? And more importantly, what didn’t work?
Some important areas to consider and review within your BCP self-assessment include:
- Were there any elements of your business that were impeded due to quarantine?
- Were you unable to mail quarterly statements or the Form ADV material changes notification?
- What happened to your firm’s mail?
- Did the inability to access your offices impact the receipt of important materials delivered via postal service?
- If your practice performed bill-paying services, did the fact that your office was closed impede your ability to provide those services to clients?
- Did you need to implement new policies to govern employees’ maintaining books and records at their personal residences due to WFH protocols?
- Prior to the pandemic, were all employees set up on secure remote access?
- Did you suddenly have to allow employees to utilize their own electronic devices to perform work functions and maintain client records?
Performing a BCP self-assessment will help memorialize where your company saw success and which areas needed improvement. Specific areas to evaluate within the self-assessment should include communications, technology, cybersecurity, how mission critical vendors performed, personnel considerations and any impact to your clients.
To read the full chapter on business continuity and preparing for regulatory exams post-pandemic, download The CCO’s Playbook.
The Case for an Interim Evaluation of your Compliance Program
How prepared was your firm for the disruption of COVID-19 pandemic? Did your firm’s business continuity plan cover a pandemic? Have you adapted your compliance program since March?
The COVID-19 pandemic has forced many to rethink best practices in the face of adapting to the “new normal.” Whether your firm is continuing to work from remote locations or is beginning to get back to the office, the disruptions of the past few months require an “other-than-annual” or interim evaluation of your firm’s compliance program, particularly with respect to high risk areas. Consider:
- What worked as intended?
- What exceptions were made to policies or procedures?
- Has the required documentation been maintained?
These are just some of the questions that compliance officers need to ask and, more importantly, answer.
There are many reasons for conducting an interim review of aspects of a firm’s compliance program. One is our short-term memory. While we all think that we will remember why an exception was made or how a situation was resolved, we generally will not without benefit of good documentation. Mitigate your own risk and download CSS’s BCP checklist.
Additionally, as our experiences post-2008 demonstrated, regulators will question what challenges the firm faced during these turbulent times and how they were addressed. They will also expect that policies and controls were followed and exceptions were documented.
Compliance officers are central to documenting how a firm responded to these business disruptions and recommending what enhancements or changes should be made to a firm’s compliance program.
To read the full chapter on assessing your compliance program, download The CCO’s Playbook.