On August 26, the U.S. Securities and Exchange Commission (SEC) adopted definitional changes that will impact private investors. The SEC amended the definition of “accredited investor” under SEC Rule 501(a) and the definition of “qualified institutional buyer” under 144A of the Securities Act of 1933 (the “Securities Act”). These definitional changes expand the scope of individuals and entities permitted to invest in private sales by issuers.

Expansion of “Accredited Investor” Definition

Regulation D under the Securities Act provides exemptions from the registration requirement for certain offers and sales of securities. Only accredited investors may purchase in a Rule 506(c) offering, and only a limited number of accredited investors may purchase in a Rule 506(b) offering. The amendment to the “accredited investor” definition in Rule 501(a) adds new categories of qualifying natural persons and entities. The “accredited investor” exemption is most commonly used by private entities.

The new definition adds two new non-financial categories of natural person accredited investors. The first includes natural persons who hold certain professional certifications or designations or other credentials as designated from time to time by order of the SEC. The SEC concurrently entered an order, specifying persons holding Series 7, 65 and 82 licenses to qualify. The second adds a “knowledgeable employee,” for example, a high-level executive or qualifying investment personnel at a private fund for investing in that private fund.

Under the first of these two changes, in new Rule 501(a)(10), an accredited investor includes “Any natural person holding in good standing one or more professional certifications or designations or credentials from an accredited educational institution that the Commission has designated as qualifying an individual for accredited investor status.” In the adopting release, the Commission explained that “if an accredited educational institution, self-regulatory organization, or other industry body believes that it has a program of study or credential that fulfills the nonexclusive list of attributes enumerated in 501(a)(10), such institution or body may apply to the Commission for consideration as a qualifying professional certification or designation or credential under 501(a)(10). Similarly, members of the public may wish to propose to the Commission that a specific degree or program of study should be included in the accredited investor definition.” (Emphasis added) This provision could result in a considerable expansion of the persons eligible to invest in exempt transactions.

The SEC added additional entities that will now also qualify as accredited investors. The current rule provides that certain entities with over $5 million in assets qualify as accredited investors, while others, including regulated entities such as banks and registered investment companies, are not subject to the assets test. The new rule includes as accredited investors: SEC and state registered investment advisers; rural business investment companies (RBICs); LLCs with total assets in excess of $5 million that are not formed for the specific purpose of acquiring the securities being offered; any form of entity not covered under the current rule (e.g., Native American tribal entities, non-U.S. pension plans or sovereign wealth funds) owning “investments” in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered; “family offices” with at least $5 million in assets under management that are not formed for the specific purpose of acquiring the securities offered and whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family offices are capable of evaluating the merits and risks of the prospective investment; and “family clients ” of a “family office” qualifying as an accredited investor.

The Commission did not alter the long-standing accredited investor category of natural person with a specified annual income or net worth. In a joint statement, Commissioners Allison Herren Lee and Caroline Crenshaw criticized the Commission’s action for failing to index the wealth threshold to inflation, that the new definition does not address risks to seniors or promote visibility into the private market. By contrast, Commissioner Hester Pierce asked, “Why shouldn’t mom and pop retail investors be allowed to invest in private offerings? Why should I, as a regulator, decide what other Americans do with their money?”

Expansion of “Qualified Institutional Buyer” Definition

The SEC expanded the categories of entities in the definition of “qualified institutional buyer” for permitted purchasers in resales exempt from registration under Rule 144A. The SEC originally created the “qualified institutional buyer” exemption in order to identify a class of investors that can be conclusively assumed to be sophisticated and in little need of the protection afforded by the Securities Act’s registration provisions.”[1]

The amendments to the qualified institutional buyer definition in Rule 144A add limited liability companies and RBICs to the types of entities that are eligible for qualified institutional buyer status if they meet the $100 million in securities owned and invested threshold.[2] The amendments also add a “catch-all” category to include institutional accredited investors within the meaning of amended Rule 501(a), of an entity type not already included in the qualified institutional buyer definition, to qualify as qualified institutional buyers when they satisfy the $100 million threshold.[3]

[1] See Resale of Restricted Securities; Changes to Method of Determining Holding Period of Restricted Securities Under Rules 144 and 145, Release No. 33-6806 (Oct. 25, 1988) [53 FR 44016 (Nov. 1, 1988)].

[2] The current list of institutions eligible for qualified institutional buyer status if they meet this $100 million in securities owned and invested threshold, include: insurance companies; registered investment companies; small business investment companies; state employee benefit plans; and employee benefit plans under ERISA.

[3] To meet the definition of a “qualified institutional buyer” under Rule 144A, one must in the aggregate own and invest on a discretionary basis at least $100 million in securities of issuers. Banks and other financial institutions are subject to an additional minimum audited net worth requirement of $25 million.