On Aug. 26, 2020, the Securities and Exchange Commission (SEC) adopted amendments to the definition of “accredited investor” under Rule 501 of Regulation D and the definition of “qualified institutional buyer” under Rule 144A of the Securities Act of 1933, as amended.
The final rules are largely consistent with the definitions in the SEC’s proposed rules released in December 2019, and will become effective 60 days after their publication in the Federal Register. These amendments are part of the SEC’s ongoing effort to simplify, harmonize and improve the exempt offering framework.
Expansion of the Definition of Accredited Investor
The amendments expanded the definition of “accredited investor” in Rule 501(a) of Regulation D to now include the following:
- Certain Designated Professionals. Natural persons holding in good standing one or more professional certifications, designations or credentials from an accredited educational institution designated by the SEC from time to time. In determining whether to designate a professional certification, designation or credential from an accredited educational institution, the SEC will consider, among other things: (i) the certification, designation or credential arises out of an examination or series of examinations administered by a self-regulatory organization or other industry body or is issued by an accredited educational institution; (ii) the examination or series of examinations is designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing; (iii) persons obtaining such certification, designation or credential can reasonably be expected to have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment; and (iv) an indication that an individual holds the certification or designation either is made publicly available by the relevant self-regulatory organization or other industry body, or is otherwise independently verifiable. The SEC issued an initial order designating as accredited investors natural persons holding, in good standing, the Series 7, Series 65 and Series 82 licenses. The SEC may, by order, add other certifications, designations or credentials in the future, after notice and an opportunity for public comment. The current list of recognized designations will be posted on the SEC’s website.
- Knowledgeable Employees. Natural persons who are “knowledgeable employees,” as defined in Rule 3c-5(a)(4) of the Investment Company Act of 1940 as amended, of an issuer that is a private fund relying on the exclusion from the definition of “investment company” under Section 3(c)(1) or 3(c)(7) of the Investment Company Act. This includes, among other persons, executive officers, directors, general partners, trustees and advisory board members, or persons serving in a similar capacity, of a Section 3(c)(1) or 3(c)(7) fund or an affiliated person of the fund that oversees the fund’s investments, as well as employees of the private fund or the affiliated person of the fund (other than employees performing solely clerical, secretarial or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund for at least 12 months. A knowledgeable employee’s accredited investor status will be attributed to his or her spouse with respect to joint investments made by the knowledgeable employee and his or her spouse in a private fund.
- Investment Advisers. SEC-registered and state-registered investment advisers, and exempt reporting advisers under Section 203(m) or Section 203(l) of the Investment Advisers Act of 1940, as amended.
- RBICs. Rural business investment companies (RBICs) as defined in Section 384A of the Consolidated Farm and Rural Development Act.
- Family Offices and Family Clients. “Family offices” (as defined under the Investment Advisers Act) with at least $5 million in assets under management, that are not formed for the specific purpose of investing in the securities being offered, and whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment. This also includes any “family client” of a family office meeting the standards above.
- Other Entities Meeting $5 Million Investment Threshold. Entities (including Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries) not covered by other categories of the accredited investor definition that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that are not formed for the specific purpose of investing in the securities offered.
The amendments also made the following changes:
- Codified the SEC’s existing guidance that limited liability companies meeting the $5 million asset test and other conditions of Rule 501(a)(3) are accredited investors. In the final rule release, the SEC staff also expressed its belief that managers of limited liability companies are included in the definition of “executive officer” (as performing a “policy making function”) with no necessity to amend Rule 501(a)(4) or Rule 501(f) to specifically include managers of companies.
- Added the term “spousal equivalent,” defined as a cohabitant occupying a relationship generally equivalent to that of a spouse, to the accredited investor definition, so spousal equivalents may pool their finances for the purpose of qualifying as accredited investors under the joint income and net worth tests for individual accredited investors.
- Clarified that, in determining accredited investor status under Rule 501(a)(8) (for an entity in which all equity owners are accredited investors), one may look through various forms of equity ownership to natural persons.
Expansion of the Definition of Qualified Institutional Buyer
The amendments to the definition of “qualified institutional buyer” in Rule 144A made the following changes:
- Added limited liability companies and RBICs to the list of entities that will qualify as qualified institutional buyers if they own and invest at least $100 million in securities of non-affiliated issuers.
- Added a catch-all for any institutional investors included in the “accredited investor” definition that are not otherwise enumerated in the definition of “qualified institutional buyer” to qualify as qualified institutional buyers, provided that they satisfy the $100 million threshold.
No Adjustments to Existing Dollar Thresholds
The amendments did not increase the existing income, net worth or asset thresholds under the previous accredited investor definition. Accordingly, persons qualifying as “accredited investors” prior to the rule amendments will remain accredited investors as long as they continue to meet those standards.
Review of Accredited Investor Definition Every 4 Years
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC is required to review the definition of accredited investor at least every four years, with the next review anticipated in 2023.
The amendments will expand the pool of potential accredited investors and qualified institutional buyers, which should increase the potential capital available in private and Rule 144A offerings, and make it easier for issuers to find and attract investors in these offerings. Issuers should be mindful of the effective date of these amendments and update their subscription/purchase agreements, investor questionnaires and other offering documents accordingly.
For additional guidance on the information in this alert, please contact any of the authors below, any member of McGuireWoods’ securities compliance or securities enforcement teams or your primary McGuireWoods contact.
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