The SEC adopted amendments on August 26, 2020 by a 3-2 vote, to expand the definition of “accredited investor,” paving the way for certain financially sophisticated institutional and individual investors to participate in private capital market offerings.  The SEC release notably invited members of the public to propose to the Commission additional specific certifications, designations, degrees, or programs of study that should qualify someone to be an accredited investor. 

Background Statements of Commissioners

Commissioner Hester M. Peirce issued a statement in support of the amendments, but questioned whether the SEC should be acting as a "merit" regulator.  Peirce questioned the accredited investor concept in general, noting it assumes that individuals cannot be trusted to exercise proper due diligence before making an investment decision.

On the other side of the fence, Commissioners Allison Herren Lee and Caroline Crenshaw issued a joint statement criticizing the amendments, noting they failed to update 38-year old wealth thresholds and to index the thresholds to inflation.  They also expressed concerns about lack of disclosure in private capital market offerings.

In a separate statement, Chairman Jay Clayton addressed some of the concerns raised by Commissioners Lee and Crenshaw.  "It is not clear that, for example, persons with $1.5 million in net worth are any more financially sophisticated than persons meeting the current $1 million threshold or persons with $500,000 or $50,000 in net worth."  Chairman Clayton also said it would be inappropriate to take away the right of current accredited investors to continue to participate in private capital markets if thresholds changed and they no longer qualified. 

The amendments will be effective 60 days after publication in the Federal Register.

Amendments to Rule 501(a), Rule 215, and Rule 144A of the Securities Act

Accredited Investors.  The amendments to the accredited investor definition in Rule 501(a):

• add a new category for natural persons to qualify as accredited investors based on holding in good standing certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.  The Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.  Members of the public are invited to propose additional certifications, designations or credentials for the Commission's consideration;
  • The Commission will provide notice and an opportunity for public comment before issuing any final orders, and will post any recognized credentials on its website.

• include as accredited investors, for investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
  • The term, which is the same in scope as the definition of “knowledgeable employee” under rules of the Investment Company Act, includes, among other persons, trustees and advisory board members, or persons serving in a similar capacity, of certain funds exempt under such Act 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.

• codify the Commission staff’s position that limited liability companies with $5 million in assets may be accredited investors;
  • The Commission stated that it is unnecessary to specifically address the status of managers of limited liability companies, on the basis that, through their knowledge and management of the issuer, they are likely to be financially sophisticated and capable of fending for themselves in investing and they perform a policy-making function for the issuer equivalent to that of an executive officer of a corporation.
  • Similarly, the Commission does not believe it necessary to distinguish between member managers and third-party managers, as either could be considered an executive officer.

• add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of persons or entities that may qualify;
• add a new category for any entity, which the Commission indicated would include Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
  • The intent of this new category is to capture all entity types not already included in the definition of accredited investor as well as those entity types that may be created in the future.

• add any “family office” that (i) has at least $5 million in assets under management, (ii) is not formed for the specific purpose of acquiring the securities offered, and (iii) its 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 investments, as well as their “family clients,” as each term is defined under the Investment Advisers Act;
• add the term “spousal equivalent” (defined as a cohabitant occupying a relationship generally equivalent to that of a spouse) to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors, as now permitted for married couples.

The amendments also incorporate certain Staff interpretations:

• that the calculation of “joint net worth” for purposes of Rule 501(a)(5) can be the aggregate net worth of an investor and his or her spouse (or spousal equivalent), and that the securities being purchased by an investor relying on the joint net worth test of Rule 501(a)(5) need not be purchased jointly.
• that, in determining accredited investor status under Rule 501(a)(8), one may look through various forms of equity ownership to natural persons. Thus, if those natural persons are themselves accredited investors, and if all other equity owners of the entity are accredited investors, the entity would be an accredited investor under Rule 501(a)(8).

The Commission considered but declined to adopt certain other changes:

The amendment to Rule 215 replaces the existing definition of accredited investor with a cross reference to the definition in Rule 501(a). Rule 215 defines the term for purposes of Section 4(a)(5), which exempts certain public offers and sales of up to $5 million made solely to accredited investors.

Qualified Institutional Buyers.  The amendments expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and rural business investment companies (RBICs) if they meet the $100 million in securities owned and invested threshold in the definition. 

The amendments also add to the list any institutional accredited investor, as defined in Rule 501(a), that is not otherwise enumerated in the definition of “qualified institutional buyer,” provided it satisfies the $100 million threshold. To address the potential for confusion due to the reference to Rule 501(a), the amendments include a note to clarify that the entity seeking qualified intuitional buyer status under that provision may be formed for the purpose of acquiring the 144A securities being offered.

Conforming Amendments.  The Commission also adopted conforming amendments to Rule 163B under the Securities Act, which relates to testing-the-waters, and to Rule 15g-1 under the Exchange Act, which relates to penny stock disclosure obligations of broker-dealers.

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