Banking and Business Monthly – September 2020

On August 26, 2020, the Securities and Exchange Commission (“SEC”) issued a final rule, adopting amendments to expand the definitions of “accredited investor” and “qualified institutional buyer.” Previously, the requirements for an individual to be considered an accredited investor were based on wealth or income tests. The new amendment modernized this classification, allowing individuals to qualify as accredited investors based on knowledge and expertise. In an explanation of this amendment, SEC Chairman Jay Clayton stated that investors who “do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks” in exempt offerings should be able to qualify as accredited investors.

The SEC retains the ability to designate which professional certifications or credentials would qualify a person as an accredited investor. Currently, the SEC has designated that holders of Series 7, Series 65, and Series 82 licenses could qualify as accredited investors. These requirements can change over time as the SEC deems appropriate under this new amendment. The SEC has made these changes because it believes that “relying solely on financial thresholds as an indication of financial sophistication is suboptimal” and that doing so could unduly restrict access to investment opportunities by persons who have the knowledge and expertise to understand the risks and merits of prospective investments. In addition to expanding the requirements for individuals, this amendment also adds a “spousal equivalent” classification. This allows individuals who are “spousal equivalents” to pool their resources in order to qualify as accredited investors.

This newly expanded definition of an accredited investor also includes individuals who qualify as “knowledgeable employees.” Knowledgeable employees are defined in the Investment Companies Act of 1940 as (1) directors, officers, trustees, general partners, advisory board members or persons serving in a similar capacity of a private fund or an affiliated management person, or (2) an employee or affiliated management person of a private fund whose regular functions or duties include participating in the investment activities of a private fund or investment company. The investment activities must have been a function of said employee for at least 12 months for him or her to qualify as a knowledgeable employee.

The amendment also adds a new qualification category for entities, as long as they were not formed for the specific purpose of investing in the securities offered, and provided they own “investments,” as defined in Rule2a51-1(b) of the Investment Company Act, totaling at least $5 million. This category includes, but is not limited to, entities such as limited liability companies, Indian tribes, governmental bodies, funds, and entities organized under laws of foreign countries.

The amendment adds another new category to the accredited investor definition for “family offices” as defined in Section 275.202(a)(11)(G)-1 of the Investment Advisers Act of 1940. A family office can qualify as an accredited investor if; (1) it has least $5 million in assets, (2) it is not formed for the specific purpose of acquiring the securities offered, and (3) its prospective investment is directed by a person who has the knowledge and expertise required to competently evaluate the risks and merits of the prospective investment. The amendment includes in this category “family clients” of family offices that meet the above requirements and whose prospective investment in the issuer is directed by the family office.

In conjunction with expanding the definition of an accredited investor, the amendment also expands the definition of a qualified institutional buyer. The expanded definition includes limited liability companies and rural business investment companies that have $100 million in securities owned and invested. It also includes institutions that qualify as accredited investors and meet this $100 million ownership and investment threshold, even if they are not specifically enumerated in the definition of a qualified institutional buyer.

These amended definitions signal that the SEC is modernizing its rules. The SEC has admitted that, despite these new definitions, it does not expect to see a significant increase in individuals who now qualify as accredited investors but who otherwise would not. Critics of the SEC argue that these amendments are not expansive enough to make a real difference and that the SEC should have made the newly amended definitions even broader. Regardless of the speculated impact of these changes, it will be critical for both prospective individual and institutional investors to understand the amendments and monitor the SEC for any future modifications. The amendments will go into effect 60 days after their publication in the Federal Register. 

If you have any questions about this article, please contact Steve at smigala@lavellelaw.com or 847-705-7555.