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.