SEC Expands Accredited Investor and Qualified Institutional Buyer Definitions

On August 26, 2020, the Securities and Exchange Commission (SEC) voted 3-2 to adopt amendments to the definition of “accredited investor” in Rule 501(a) of Regulation D (Reg D) under the Securities Act of 1933 (Securities Act) and the definition of “qualified institutional buyer” under Rule 144A (Rule 144A) under the Securities Act. The final rule largely follows the SEC's amendments proposed in December 2019.

The accredited investor standard establishes categories of natural persons and entities that may purchase securities offered in an SEC Rule 506 private placement without counting against the 35-purchaser limit. The amendments passed by the SEC incorporate new categories of natural persons and entities into the definition and modify the existing list of entities that may qualify to be more inclusive, which will expand the number of investors permitted to participate in private securities offerings, including hedge funds, venture capital funds and private equity funds.

Most notably, the new rule will allow individuals for the first time to qualify as accredited investors based on measures of financial sophistication other than their income or net worth.

The new rule will go into effect 60 days after publication in the Federal Register.

The following chart provides a brief description of the updates to the accredited investor definition, which are discussed in more detail below. A chart setting forth all of the criteria for being an accredited investor for individuals and entities, including the amendments, is included at the end of this alert.

Natural Persons

The SEC added two new categories to the definition allowing natural persons to qualify as accredited investors. The update will permit natural persons to qualify as accredited investors based on certain professional certifications, designations or other credentials issued by an accredited educational institution, as designated by the Commission from time to time by order. In conjunction with the rule release, the SEC issued an order delineating the initial professional certifications or designations or credentials that provide accredited investor status. The order provides that holders in good standing of the Series 7, Series 65 and Series 82 licenses qualify as accredited investors. The SEC will continue to consider additional professional qualifications based on a non-exclusive list of attributes set forth in the rule and may designate additional professional certifications or designations or credentials by order following notice and an opportunity for public comment. Our expectation is that this list will grow over time.

A natural person that is investing in a private fund and is a knowledgeable employee, as defined in Rule 3c-5(a)(4) under the Investment Company Act, also now qualifies as an accredited investor.

The SEC also revised Rule 501(a)(5) and (6) to incorporate the concept of a spousal equivalent, which  permits natural persons to include joint income from a spousal equivalent when calculating joint income and when determining net worth. Spousal equivalent is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse and such definition is consistent with the definition employed in existing rules.

Entities

Three new categories were added to the accredited investor definition, and several existing categories were modified in order to include additional types of entities.

Rule 501(a)(1) was modified to include SEC and state-registered investment advisers, exempt reporting advisers, and RBICs to the list of entities that qualify. The SEC also codified the long-standing staff position that limited liability companies with $5 million in assets are accredited investors under Rule 501(a)(3).

Entities that have long been excluded from the accredited investor definition – including Indian tribes, governmental bodies and funds, and entities organized under the laws of foreign countries – may now qualify under a new category which permits any entity owning “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered to qualify. There were many requests for the SEC to incorporate a list of the types of entities that may qualify under the new category, but the SEC declined to do so, noting in its release that the intent of the rule is to capture all types of entities not already included in the definition and those types of entities that may be created in the future.

The last new category added to the rule provides for any family office, as defined under the Advisers Act – with at least $5 million in assets under management, that was not formed for the specific purpose of acquiring the securities offered, and is directed by a person with the knowledge and experience necessary to evaluate the merits and risk of the investment – to qualify as accredited. Family clients of a family office, as each term is defined under the Advisers Act, may also qualify, but such family clients’ prospective investment must be directed by a family office meeting the aforementioned requirements.

The SEC also added a note to Rule 501(a)(8), which clarifies that when determining accredited investor status under Rule 501(a)(8), one may look through multiple levels of equity ownership to natural persons. If those natural persons are themselves accredited investors, and if all other equity owners of an entity are accredited investors, the entity would be an accredited investor under Rule 501(a)(8).

Qualified Institutional Buyer

The amendments expanded the definition of a qualified institutional buyer in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition. The amendments also incorporated a catch-all which allows any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of a qualified institutional buyer, provided they satisfy the $100 million threshold, to qualify as a qualified institutional buyer.

The rule is available here. The SEC order is available here.

Chart Setting Forth All Current Categories of Accredited Investor