SEC Expands Accredited Investor and Qualified Institutional Buyer Categories
In Short
The Situation: The term "accredited investor" under the Securities Act of 1933 ("Securities Act") is used to establish the eligibility of investors to participate in offerings conducted under the most frequently used private placement exemptions. The U.S. Securities and Exchange Commission ("SEC") has considered, from time to time over the last several decades, modifying the coverage of the term to incorporate additional categories of individuals and entities.
The Result: The SEC expanded the investor eligibility criteria to qualify as accredited investors and qualified institutional buyers ("QIBs").
Looking Ahead: Additional investors will be able to participate in securities offerings conducted pursuant to Rules 506(b) and 506(c) of Regulation D (including private fund offerings) and in offerings conducted pursuant to Rule 144A.
On August 26, 2020, the SEC adopted a final rule ("Final Rule") that will expand the definitions of "accredited investor" and "qualified institutional buyer" as used in rules promulgated under the Securities Act. The terms establish important qualifications for determining investor eligibility for certain private securities offerings. The Final Rule will amend Rules 215, 501(a), and 144A under the Securities Act effective 60 days after publication of the Final Rule in the Federal Register.
Importantly, the amendments did not include any changes to the income and net worth threshold required for individuals. The income and net worth thresholds for individuals generally are in excess of $200,000 of income per year (or over $300,000, together with their spouse) or a net worth of more than $1 million (excluding the value of their home).
A summary of the notable aspects of the Final Rule is set out below.
"Accredited Investor" Definition
Natural Persons
- Professional Certifications and Designations or Other Credentials. The Final Rule adds a category for natural persons to qualify as accredited investors if they hold in good standing certain professional certifications, designations, or other credentials that the SEC may from time to time designate by order. Concurrently with the Final Rule, the SEC issued an order designating Financial Industry Regulatory Authority Series 7 (General Securities Representative), 65 (Investment Adviser Representative), and 82 (Private Securities Offerings Representative) licenses as satisfying the attributes to qualify natural persons holding them in good standing as accredited investors.
- Knowledgeable Private Fund Employees. The Final Rule allows persons qualifying as "knowledgeable employees" of a private fund (such as hedge, private equity, and venture capital funds), as defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940, to qualify as accredited investors for investments in the private fund. This new category of accredited investor will generally include executive officers, directors, general partners, or persons in similar capacities and certain fund employees who, in connection with their regular functions, have participated in a fund's investment activities for at least a year.
- Spousal Equivalents. The Final Rule provides that in assessing income requirements for natural persons, joint income from "spousal equivalents" (i.e., a cohabitant in a relationship equivalent to that of a spouse) may be taken into account.
Entities
- Limited Liability Companies. The Final Rule codifies the long-held SEC staff position that limited liability companies ("LLCs") with total assets of more than $5 million that were not established for the specific purpose of acquiring the securities being offered qualify for accredited investor status.
- Certain Family Offices and Family Clients. A "family office" (as defined in SEC Rule 202(a)(11)(G)-1 ("Family Office Rule")) qualifies as an accredited investor under the Final Rule, provided that the family office has at least $5 million in assets under management, was not established for the particular purpose of acquiring the securities offered, and its prospective investments are directed by a person who possesses knowledge and experience in financial and business matters such that the family office is able to evaluate the merits and risks of the investment. Accredited investor status will also be afforded to "family clients" (as defined in the Family Office Rule) of a family office that meets the foregoing requirements, whose prospective investment in the issuer is directed by that family office.
- Other Entities. The Final Rule also extends accredited investor status to:
- SEC- and state-registered investment advisers, and exempt reporting advisers (i.e., advisers that rely on either of the Venture Capital Fund Adviser Exemption or the Private Fund Adviser Exemption under the Investment Advisers Act of 1940);
- Rural Business Investment Companies ("RBICs"); and
- All entity types not included in other categories (e.g., Indian tribes, governmental bodies, funds and entities organized offshore) that own "investments" of more than $5 million that were not formed for the particular purpose of acquiring the securities being offered.
"Qualified Institutional Buyer" Definition
The Final Rule broadened the definition of "qualified institutional buyer" under Rule 144A to include LLCs and RBICs as long as they satisfy the $100 million in securities owned and invested threshold in the QIB definition. The Final Rule also provides that institutional "accredited investors" that are of a type not otherwise listed in the QIB definition, but meet the $100 million threshold, qualify as QIBs.
Three Key Takeaways
- Subscription documentation for private offerings for which "accredited investor" status is a key component (e.g., Rules 506(b) and 506(c)) will need to be updated to include references to the new categories. This will also be the case for QIB status representation letters (to the extent that they delineate investor categories), as well as computer software (e.g., on platforms) that electronically collect investors' "accredited investor" and "qualified institutional buyer" representations.
- The Final Rule will have the impact of avoiding some uncertainty that currently exists as to the eligibility of certain types of entities (e.g., those not specifically named in the Rules) for "accredited investor" and "qualified institutional buyer" status, thereby eliminating some of the need for interpretive status guidance for the expanded group.
- For those issuers that rely on Rule 506(c) for their private offerings, the expanded universe of potential "accredited investors" will require such issuers to newly assess the types of documentation that will be necessary in order to properly establish the qualifications of the expanded types of accredited investors.
