On Aug. 26, the Securities and Exchange Commission adopted amendments to the definitions of "accredited investor" and "qualified institutional buyer." The amendments to the "accredited investor" definition for the first time include individuals based on certain measures of financial sophistication other than just their income and net worth, and expand the list of qualifying entities. The amendments to the "qualified institutional buyer" definition also expand the list of qualifying entities, including institutional investors that are accredited investors and meet the existing $100 million investment threshold discussed below.
The Securities Act of 1933, as amended, requires that every offer and sale of securities be registered with the SEC, unless an exemption is available. The accredited investor definition is a central component of several exemptions to the registration requirements, including Rule 506 of Regulation D, and enables qualifying investors to participate in investment opportunities that are not available to the general public. The SEC stated that Rule 506 offerings to accredited investors occur with greater frequency than any other type of private securities offering,1 and estimated that in 2019, the amount of capital raised in Rule 506 offerings was approximately $1.56 trillion, or 40% of all new capital raised that year.2 As such, amendments to the accredited investor definition have the potential to impact capital markets significantly.
The existing definition of accredited investor is set forth in Rule 501(a) of Regulation D. It states that natural persons are accredited investors if they (i) have a net worth of at least $1 million or (ii) have an individual income of at least $200,000 or joint income with their spouse of at least $300,000, in each of the two most recent years, with a reasonable expectation of reaching the same level of income in the current year. In addition, entities are generally considered accredited investors if they have at least $5 million in total assets, with certain entities such as banks, broker-dealers and insurance companies qualifying automatically.
Rule 144A under the Securities Act is another exemption to the securities registration requirements and allows the private resale of unregistered securities to qualified institutional buyers. Under the existing definition, qualified institutional buyers are generally large institutional investors such as investment companies and banks that own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity.
Amendments to the Definitions of Accredited Investor and Qualified Institutional Buyer
The amendments adopted by the SEC to the accredited investor definition:
- Permit natural persons to qualify as accredited investors based on certain professional certifications or credentials, which the SEC may designate from time to time. In conjunction with the adoption of these amendments, the SEC designated holders of the Series 7, Series 65 and Series 82 licenses as qualifying natural persons, and the amendments give the SEC the flexibility to include additional certifications or credentials in the future.
- Include, with respect to investments in a private fund, natural persons who are "knowledgeable employees" of the fund.
- Clarify that limited liability companies with $5 million in assets may be considered accredited investors, and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify.
- Add a new category for any entity, including Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries, that owns investments, as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
- Add "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.
- Add a "spousal equivalent" who may pool his or her finances for the purpose of qualifying as accredited investors.
The amendments to the qualified institutional buyer definition in Rule 144A include limited liability companies and RBICs, so long as they own and have invested $100 million in securities. Furthermore, any institutional investor that is an accredited investor and satisfies the $100 million ownership and investment threshold will now also qualify as a qualified institutional buyer.
Although the amendments adopted by the SEC to the definitions of accredited investor and qualified institutional buyer do not greatly expand the number of investors that may participate in private capital markets immediately, in adopting these amendments the SEC invited members of the public to propose additional certifications or credentials that may satisfy the new rule, which could lead to broader participation in the future. The SEC issued a final rule adopting these amendments on Aug. 26, which will go into effect 60 days after publication in the Federal Register.
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