SEC proposes expanded definitions of “accredited investor” and “qualified institutional buyer”

On Dec. 18, 2019, the SEC proposed an amendment to the definition of “accredited investor” which would expand the potential pool of institutional and individual investors that may participate in private securities offerings.¹ This proposed amendment would allow additional individual investors with sufficient knowledge, experience, or certifications to qualify as an accredited investor and participate in private offerings. Additionally, the SEC proposed similar amendments to expand the definition of “qualified institutional buyer” in Rule 144A of the Securities Act of 1933 (as amended, the Securities Act), potentially defining a qualified institutional buyer as any entity that meets the investment test explained below.

Because the accredited investor definition serves as a central element of multiple private offering exemptions under the Securities Act, including Rules 506(b) and 506(c) of Regulation D, the SEC has proposed these amendments as an “initial step in a broader effort to consider ways to harmonize and improve the exempt offering framework.”² The goal is to identify more effectively potential investors that have sufficient knowledge and expertise to participate in private offerings and “therefore do not need the additional protections” of the Securities Act.³

Currently, to qualify as an accredited investor and be eligible to participate in certain exempt offerings under Regulation D, a potential investor must qualify as one of the following: (i) an individual with a net worth of more than $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence) or who has earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years; (ii) an organization with more than $5 million in assets not formed specifically to purchase the securities at issue, whose purchase is directed by a sophisticated person, (iii) any entity in which all of the equity owners are accredited investors, or (iv) a bank, institution, or other entities that meet certain defined requirements more fully set forth in Rule 501(a) of Regulation D.⁴

Should the proposed amendments go into effect, however, additional individuals would qualify as accredited investors, thereby expanding the pool of potential investors that may participate in an exempt, private offering under the Securities Act. Specifically, the proposed amendments would revise the definition of “accredited investor” to include:

• Individuals with certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution.
• "Knowledgeable employees” of a private fund seeking to invest in the fund, including: (i) executive officers, directors, trustees, advisory board members or persons serving in a similar capacity of certain funds or affiliated persons of the fund that oversee the fund’s investments, and (ii) employees or affiliated persons of the fund (other than solely administrative employees) who have participated in the investment activities of such fund for at least 12 months.
• Limited liability companies that meet certain conditions, registered investment advisers and rural business investment companies (RBICs).
• Any entity, including Indian tribes, owning certain “investments” in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
• "Family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act, so long as the securities purchases of the family office are directed by a person with sufficient financial and business knowledge.
• "Spousal equivalents” (i.e., a cohabitant occupying a relationship generally equivalent to that of a spouse, such as a domestic partner or partner in a civil union), who may pool their finances for the purpose of qualifying as accredited investors.⁵

Furthermore, the proposed amendments would revise the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs that own and invest more than $100 million in securities. Finally, the proposed amendments would add a “catch-all” under Rule 501(a) so that any entity, including Native American tribes, that owns and invests more than $100 million in securities would qualify as a “qualified institutional buyer” so long as that entity was not formed for the specific purpose of purchasing the securities at issue.

Overall, the proposed amendments reflect the SEC’s attempt to balance the importance of exempt offerings under Regulation D in the U.S. capital markets with the additional investment risks that these offerings pose to potential investors when compared to registered offerings. While the proposed amendments may expand the pool of potential investors in these offerings, the details of the amendments have not been finalized, including the scope of the professional certification and credential framework. Moreover, the amendments set forth over 60 questions for public comment, meaning the final breadth and scope of the proposed amendments will most certainly change following the public comment period, which remains open until March 16, 2020.6

Please contact a McDonald Hopkins attorney listed below to see how these proposed amendments may affect your business and capital raising efforts moving forward.

[1] See, SEC. (Dec. 18, 2019) SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments [Press Release].
[2] See, SEC. (Jan. 31, 2019) Updated Investor Bulletin: Accredited Investors
[3] Id.
[4] Id.
[5] See, SEC. (Dec. 18, 2019) SEC Proposes to Update Accredited Investor Definition to Increase Access to Investments [Press Release].
[6] Id.