On August 26, 2020, the US Securities and Exchange Commission adopted amendments to the definitions of “accredited investor” and “qualified institutional buyer” under the Securities Act of 1933, as amended (Securities Act), substantially as proposed (see our corporate client alert summarizing the SEC’s December 2019 proposed release here). As noted by the SEC in the final rule release, the significance of the exempt securities markets has increased — in terms of both the amount raised and their relation to public registered markets (in 2019, registered offerings accounted for $1.2 trillion (30.8%) of new capital, compared with approximately $2.7 trillion (69.2%) the SEC estimates was raised through exempt offerings) — and the amendments are part of a broader effort to simplify, harmonize, and improve the exempt offering framework; promote capital formation; and enhance investment opportunities, all without compromising historical protections for investors. In the press release accompanying these final rules, the chairman of the SEC said, “For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations that may qualify to participate in certain private offerings.”

The full text of the amendments included in the final rule release, which will become effective 60 days following publication in the Federal Register, can be found here.

Amendments to ‘Accredited Investor’ Definition Under Regulation D (Rule 501(a))

The amendments expand the categories of natural persons and entities that qualify as accredited investors, and clarify certain aspects of the current definition, including the interplay of accredited investors with other areas of the federal securities laws. A summary of the amendments to the “accredited investor” definition, as adopted by the SEC, follows.

Professional Certifications and Designations and Other Credentials

This categorical expansion to the accredited investor definition includes natural persons holding certain professional certifications, designations, and credentials from an accredited educational institution. Unlike the historical factors for natural persons, the SEC has now codified its evolving belief that wealth should not serve as the exclusive characteristic for assessing an individual’s financial sophistication and corresponding need for additional protections under the Securities Act. As a result, this additional category qualifies these professionals independent of their net worth. In making its determination regarding a particular certification, designation, or credential, the SEC noted it will consider the following non-exhaustive list of attributes:

• 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.

• 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.

• 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.

• An indication that an individual holds the certification, designation, or credential is made publicly available by the relevant self-regulatory organization or other industry body, or the certification, designation, or credential is otherwise independently verifiable.

• The individual holding such certification, designation, or credential is in good standing with the issuing body, and such certification, designation, or credential is active. However, the SEC clarified that this attribute does not necessarily require individuals to be practicing in an area related to the certification, designation, or credential.

By separate order, the SEC specifically codified the following qualifying certifications, designations, and credentials under this expanded definition: (a) Series 7 licensed general securities representatives, (b) Series 65 licensed investment adviser representatives, and (c) Series 82 licensed private securities offerings representatives.

To address certain commenters’ concerns, the SEC advised that it would provide notice and opportunity for public comment prior to issuing any final order codifying any qualifying certifications, designations, or credentials in addition to the above. The SEC will also post to its website the professional certifications and designations that are then currently recognized as satisfying its criteria.

Additionally, the SEC noted in the final rule release that if any member of the public, accredited educational institution, self-regulatory organization, or other industry body believes that a particular program, designation, or credential satisfies these attributes, such individual or entity may apply to the SEC for consideration.

Knowledgeable Employees of Private Funds

The SEC adopted, as proposed, an additional category of accredited investors, which includes natural persons who are deemed “knowledgeable employees” of private funds under Rule 3c-5(a)(4) of the Investment Company Act of 1940. Qualifying knowledgeable employees would be considered accredited investors with respect to investments in their employer’s private fund, and would include trustees, advisory board members, and persons serving in a similar capacity, among others, of a fund defined in Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940; an affiliated person of the fund overseeing its investments; and employees of the fund or the affiliated person of the fund. However, employees performing solely clerical, secretarial, or administrative functions would not qualify.

Additional Categorical Additions to the Accredited Investor Definition

The amendments adopted by the SEC also add the following categories to the accredited investor definition under Rule 501(a) of Regulation D:

• Registered and Exempt Reporting Investment Advisers – All registered and exempt reporting investment advisers under Section 203 of the Investment Advisers Act of 1940 and all investment advisers registered under state law.

• Rural Business Investment Companies – As defined in Section 384A of the Consolidated Farm and Rural Development Act.

• Family Offices and Family Clients – As each term is defined in Rule 202(a)(11)(G)-1 in the Investment Advisers Act of 1940, including family offices with at least $5 million in assets under management and family clients (a) that are not formed for the specific purpose of acquiring the securities offered and (b) whose purchase is directed by a person with knowledge and experience in financial and business matters who is capable of evaluating the merits and risks of a potential investment. This category will also include beneficiaries that temporarily qualify as a family client under the family office rules, such as persons who receive assets upon the death of a family member or key employee (or who receive such assets from an involuntary transfer from a family member or key employee).

• Other Legal Entities Meeting the Investments-Owned Test – Entities (a) owning more than $5 million in investments (as defined in Rule 2a51-1(b) of the Investment Company Act of 1940) and (b) not formed for the specific purpose of acquiring the securities being offered. Examples of additional legal entities that qualify under the catchall provision (assuming they meet the above-listed investments-owned test) are Indian tribes, labor unions, governmental bodies and funds, and legal entities organized under the laws of a foreign country.

Clarifications to the ‘Accredited Investor’ Definition 

In addition to the above, the SEC adopted several clarifications to the definition of accredited investor, all of which codify existing staff interpretations, including:

• Adding a note to Rule 501(a)(8) to clarify that when the equity owners of a purchasing entity are also legal entities, one may look through various forms of equity ownership to the natural person equity owners of such entities to determine accredited investor status.

• Codifying a long-standing SEC staff position that limited liability companies qualify as accredited investors under Rule 501(a)(3) of Regulation D, provided that such LLCs are not formed for the specific purpose of acquiring the securities offered and have total assets in excess of $5 million.

• Clarifying that “spousal equivalents” are included in the calculation of joint income and joint net worth for the purposes of determining accredited investor status. A “spousal equivalent” is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.

• Adding a note to Rule 501(a)(5) of Regulation D to clarify that securities being purchased under the joint net worth test can be the aggregate net worth of an investor and his or her spouse (or spousal equivalent), and that those securities do not need to be purchased jointly.

Changes Outside of Regulation D Related to Accredited Investors

The amendments adopted by the SEC also:

• Conform the definition of accredited investor under Rule 215 of the Securities Act to the definition of accredited investor in Rule 501 under Regulation D, as amended.

• Add the above catchall, family office, and family client provisions of the accredited investor definition under Rule 501 of Regulation D to the (a) categories of accredited investors with which issuers may engage in test-the-waters communications under Rule 163B of the Securities Act and (b) exempt transactions under Rule 15g-1 of the Securities Exchange Act of 1934.

Changes to ‘Qualified Institutional Buyer’ Definition 

The SEC also adopted its proposed changes to the definition of “qualified institutional buyer” under Rule 144A to eliminate any inconsistencies between the definitions of accredited investor and qualified institutional buyer (QIB). Specifically, the amendments add to the definition of QIB, limited liability companies (LLCs) and rural business investment companies (RBICs), if such LLCs or RBICs meet the Rule 144A threshold of $100 million in securities owned and invested. Additionally, the SEC added a new catchall provision that enables all entity-accredited investors under Rule 501 of Regulation D that are not already included in the other provisions of Rule 144A to qualify as QIBs when they satisfy that $100 million in securities owned and invested threshold. Further, the SEC added a note to Rule 144A to clarify that entities seeking QIB status under the catchall provision may be formed for the purpose of acquiring the securities being offered pursuant to the Rule 144A safe harbor exemption.