SEC Amends Accredited Investor Definition – Rule 506 Offerings
New Accredited Investor Rules
Rule 506 Offerings are the most common of the Regulation D exemptions from registration under the Securities Act of 1933, as amended (the “Securities Act”). Rule 506 contains two distinct offering exemptions. Rule 506(b) and Rule 506(c). Rule 506 (b) provides an exemption to an unlimited number of accredited investors and up to thirty-five non-accredited investors without the use of general solicitation and advertising while Rule 506(c) allows the issuer to sell to an unlimited number of accredited investors so long as it verifies that each investors is an accredited investor.
The first question most issuers ask when considering an offering under Rule 506 is “what is an accredited investor”?
Among other requirements, Rule 506(b) allows sales of securities to up to 35 non-accredited investors while Rule 506(c) allows sales to an unlimited number of accredited investors. The SEC’s amendment to the definition of Accredited Investor now includes knowledge-based criteria. The SEC Amendment expands the definition of “accredited investor” in Rule 501(a) to include the following:
- any individual who has a professional certification, designation or credential from an accredited educational institution that the Commission designates as qualifying for accredited investor status;
- any individual who is a “knowledgeable employee” of a “private fund,” which is defined to include an issuer that would be an investment company, but for the exclusions provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940;
- any entity that owns investments in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
- any investment adviser registered under federal or state law (and Exempt Reporting Advisers relying on Section 203(m) or 203(l) of the Investment Advisers Act of 1940);
- any rural business investment company (RBIC);
- any family office with at least $5 million in assets under management and that was not formed for the specific purpose of acquiring the securities offered, and whose investment is directed by a person capable of evaluating the merits and risks of the prospective investment;
- any family client of a family office described in the prior bullet point whose prospective investment is directed by that family office; and
- limited liability companies with $5 million in assets that was not formed for the specific purpose of acquiring the securities offered.
The SEC is also amending Rule 501(a) so that a “spousal equivalent” (defined as a cohabitant occupying a relationship generally equivalent to that of a spouse) is treated the same as a spouse under Rule 501(a).
Qualifying Accredited Investor Credentials
As indicated above, the definition of Accredited Investor under Rule 501(a)(10) now includes individuals with certain professional certifications, designations or other credentials. The SEC designated the following Financial Industry Regulatory Authority (“FINRA”) professional certifications:
- the Series 7 – General Securities Representative license
- the Series 65 -Licensed Investment Adviser Representative
- the Series 82 – Private Securities Offerings Representative license
The SEC does not require that the individual with the qualifying certification, designation or credential practice in the related profession, but they must maintain the certification, designation or credential in good standing.
Sophistication of Employees of Private Funds
The SEC Amendments add an additional category to the Accredited Investor definition in Rule 501(a)(11) to include “knowledgeable employees” of a private fund. The Accredited Investor definition will cover the same individuals that are included in the definition of “knowledgeable employee” in Investment Company Act Rule 3c-5(a)(5). This includes, among other persons, trustees and advisory board members of a private fund or an affiliated person of the private fund that oversees the private fund’s investments, as well as employees of the private fund or the affiliated person of the private fund who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund for at least 12 months. Expanding the definition of Accredited Investor to include employees, permits such employees to invest in the private fund without the private fund itself losing Accredited Investor status when the private fund has assets of $5 million or less.
Implications of the Accredited Investor Amendments
The amendments will provide investors meeting the SEC’s new Accredited Investor definition with the opportunity to participate in securities offerings limited to Accredited Investors particularly under Regulation D, Rule 506. Additionally, it will provide issuers with a wider pool of potential investors.
The SEC’s Fact Sheet is set forth below.
Updating the Accredited Investor Definitions
Aug. 26, 2020
The Securities and Exchange Commission adopted amendments to update and improve the definition of “accredited investor” in the Commission’s rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act of 1933. The amendments to the accredited investor definition add new categories of qualifying natural persons and entities and make certain other modifications to the existing definition. The amendments to the qualified institutional buyer definition similarly expand the list of eligible entities under that definition.
These amendments are part of the Commission’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.
In June 2019, the Commission requested public comment on its Concept Release on Harmonization of Securities Offering Exemptions. In the Concept Release, the Commission requested comments on possible approaches to amending the accredited investor definition, which is a central component of several exemptions from registration, including Rules 506(b) and 506(c) of Regulation D, and plays an important role in other federal and state securities law contexts. The Concept Release was preceded by a Commission staff report issued in December 2015 on the accredited investor definition, which examined the background and history of the definition and considered comments and recommendations on amending the definition.
After taking into account the views expressed by members of the public and recommendations over the years from various Commission advisory committees and the annual SEC Government-Business Forum on Small Business Capital Formation, the Commission proposed in December 2019 to amend the accredited investor definition. In March 2020, the Commission continued the harmonization effort by proposing amendments to the exempt offering framework.
The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.
The amendments to the accredited investor definition in Rule 501(a):
- add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
- include as accredited investors, 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 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 own “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; 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 amendment to Rule 215 replaces the existing definition with a cross reference to the definition in Rule 501(a).
The amendments expand the definition of “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 add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
The Commission also adopted conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.
The amendments and order become effective 60 days after publication in the Federal Register.
For further information, please contact us at (561) 416-8956 or [email protected] or www.securitieslawyer101.com. This securities law blogpost is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
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