SUMMARY

The Securities and Exchange Commission voted 3-2 last week to adopt amendments to the “accredited investor” definition, one of the tests the SEC uses to determine eligibility to invest in unregistered private offerings of securities.

THE UPSHOT

  • The amendments are part of the [SEC’s] ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation,” the SEC said in a press release.
  • U.S. securities laws allow exemption from registration when an offering is directed toward only “accredited investors”—intended to mean investors with sufficient wealth and/or financial sophistication to make an investment decision without the need for enhanced disclosure and other protections afforded by registration.
  • The amendments expand the definition in several respects, including broadening investor eligibility to include individuals with certain professional certifications.

THE BOTTOM LINE

Issuers looking to conduct private offerings should review offering and purchase documentation to make the necessary revisions to disclosures and/or representations and warranties to reflect the amended accredited investor definition. They should also review any qualified institutional buyer (QIB) questionnaires in offerings conducted under Rule 144A for any necessary updates.


FULL ALERT

On August 26, 2020, the Securities and Exchange Commission, by a 3-2 vote, adopted amendments to the “accredited investor” definition, one of the tests the SEC uses to determine eligibility to invest in unregistered private offerings of securities. In its adopting release, the SEC described the changes as “part of the [SEC’s] ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.” Initially released for public comment in December 2019, the amendments to the definition (1) allow additional individual investors to participate in private offerings by creating additional categories for qualification; and (2) add new categories of entities that now qualify as institutional accredited investors. The changes will take effect 60 days after publication in the Federal Register.

Background

Under U.S. securities laws, offers and sales of securities must be registered with the SEC under the Securities Act of 1933, as amended (Securities Act), unless an exemption from registration is available. Unregistered offerings allow issuers to offer securities without the time, expense, and disclosure requirements of registration, but as a result, potential investors may be subject to additional risk. One such exemption from registration is available when an offering is directed toward only “accredited investors,” on the assumption that these investors have sufficient wealth and/or financial sophistication to make an investment decision without the need for protections of SEC registration.

Prior to the amendments, the SEC defined individual “accredited investors” as:

  • any person who earned income over $200,000 (or $300,000 jointly with a spouse) in each of the prior two years, and who reasonably expects the same for the current year; or
  • any person who has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

With respect to institutional investors, the definition generally includes banks, insurance companies, registered investment companies, business development companies, small business investment companies, certain benefit plans, entities in which all of the equity owners are accredited investors, and certain trusts and 501(c)(3) organizations with assets in excess of $5 million. In sum, the SEC defines an “accredited investor” with the aim of identifying individuals and entities that “have sufficient knowledge and expertise to participate” in unregistered offerings, using income and assets as a proxy for knowledge and expertise when needed.

Key Changes

The amendments revise the “accredited investor” definition in Rule 501(a) under the Securities Act to:
  1. add a new category to the definition that permits individuals to qualify as accredited investors based on certain professional certifications, designations, or credentials, or other credentials issued by an accredited educational institution, which the SEC may designate from time to time by order.
    The SEC noted in the adopting release that this approach gives the commission the flexibility to reevaluate certifications and designations over time, and to potentially add more certifications and designations as they develop. In a separate order, the SEC designated holders (in good standing) of the following certifications administered by the Financial Industry Regulatory Authority (FINRA) as the initial certifications to qualify under the amended definition: the General Securities Representative (Series 7), the Licensed Investment Adviser Representative (Series 65), and the Private Securities Offerings Representative (Series 82) licenses.
  2. add a new category to the definition that permits knowledgeable employees1 of private funds to qualify as accredited investors.

With respect to institutional investors, the amendments also:

  • clarify that limited liability companies with $5 million in assets may be accredited investors if they otherwise meet all of the requirements of the accredited investor definition;
  • add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of qualifying accredited investors;
  • add a new category for any entity, including Native American Tribes, that was not formed for the specific purpose of acquiring the securities being offered in a private securities offering, but that owns “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million, to the list of qualifying accredited investors;
  • add “family offices”2 with at least $5 million in assets under management and their “family clients” (as defined in Rule 202(a)(11)(G)-1 of the Investment Advisers Act) to the list of qualifying accredited investors; and
  • add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors. The SEC defines a “spousal equivalent” as a cohabitant occupying a relationship generally equivalent to that of a spouse.

Qualified Institutional Buyer and Testing the Waters Updates

The SEC also amended the definition of “qualified institutional buyer” (QIB) under Rule 144A of the Securities Act to be consistent with the amendments discussed above.

The SEC further amended Rule 163B of the Securities Act to include the revised list of institutional investors in the list of potential investors that may be privy to “testing the waters” communications before filing a registration statement with the SEC.

Policy and Practical Considerations

The 3-2 vote in favor of these amendments saw Chairman Clayton and Commissioners Peirce and Roisman voting in favor of granting more investors access to private offerings, and Commissioners Lee and Crenshaw dissenting. In dissent, Commissioners Lee and Crenshaw highlighted the amendments’ failure to index monetary wealth thresholds to inflation and the specific risks the amended definition poses to seniors who may have gradually accumulated wealth over a lifetime without financial sophistication. The dissenters also noted that and the amendments do not address a lack of transparency in private markets. In voting for the amendments, Commissioner Peirce noted that they did not go far enough to open access to private markets to everyday Americans. With an election looming this fall and Chairman Clayton’s tenure scheduled to end in 2021, the appearance of diverging policy priorities at the SEC is worth noting.

From a practical perspective, issuers looking to conduct private offerings should review offering and purchase documentation to make the necessary revisions to disclosures and/or representations and warranties to reflect the amended accredited investor definition. They should also review any QIB questionnaires in offerings conducted under Rule 144A for any necessary updates.

Ballard Spahr’s Securities and Capital Markets Group advises private and public companies on complying with public reporting, proxy, and disclosure obligations, and guides them through all stages of development and capital-raising activities.


1 A “knowledgeable employee” is defined in Rule 3c-5(a) (4) under the Investment Company Act of 1940, as amended (the “Investment Company Act”) to include, among others, an executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity, of the private fund or an “affiliated management person” (an affiliated person that manages the investment activities of a private fund) of the private fund, and certain other employees of the private fund who routinely participate in the investment activities of such private fund.

2 A “family office” is defined in Rule 202(a) (11(G)-1 of the Investment Advisers Act, as amended, as 1) in general, having no clients other than family clients, 2)being wholly owned by family clients and is exclusively controlled (directly or indirectly) by one or more family members and/or family entities and 3) does not hold itself out to the public as an investment adviser.


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