On August 26, 2020, The Securities and Exchange Commission (“SEC”) revised Rule 501(a), Rule 215, and Rule 144A of the Securities Act to broaden the definition of “accredited investor” and “qualified institutional buyer.” These amendments come into effect October 27, 2020.
Historically, the SEC has heavily regulated the sale or offering of unregistered securities. It usually restricts these offerings to “accredited investors” or “qualified institutional buyers” who meet narrow criteria. These restrictions were enacted to protect potentially unsophisticated investors from risky investment schemes. However, the restrictions also created a gap of investment opportunities between accredited and non-accredited individuals. The SEC’s recent rule revisions are intended to promote capital formation and reduce barriers to investment. These new rule revisions create new investment opportunities and risks.
“Accredited investors” can purchase securities in non-public, private offerings, allowing them to access private capital markets closed off to the general public. The investment opportunities include, amongst others, rolling-the-dice on rising start-ups, leveraged buyout firms or “token sales” or initial coin offerings (ICOs). These investments can generate outsized returns, but often carry significant risk. The SEC historically restricted such investments to regulate potentially risky investment schemes.
Under the former rules, an individual could not invest in private unregistered securities offerings unless he or she had an annual income of at least $200,000 or $1,000,000 in net assets, not including their home.
The prior definition focused on wealth as an approximate way of assessing the financial sophistication of individual investors. The result of these definitions was that typically only wealthy individuals could access private venture investments. Moreover, non-qualifying individuals with financial savvy and sophistication were prevented from accessing these markets.
As amended, “accredited investors” include individuals who have certain professional knowledge, experience or certifications, even if they do not meet the income or net asset restrictions under the old rules.
For example, the new definitions include as accredited investors financial professionals, specifically with professional certifications, designations or credentials or other credentials issued by an accredited educational institution. Any person holding basic stockbroker certifications, including Series 7, Series 65, and Series 82 licenses, is also considered an “accredited investor.” Note that chartered financial advisers are not included in this expansion of accredited investors.
Accredited investors now also include “knowledgeable employees” of certain funds and family offices with more than $5,000,000 in assets under management. “Spousal equivalents” may also pool their finances for the purpose of qualifying as accredited investors.
Notably, the SEC rejected a proposal to index the income and net worth to account for inflation, a subject of debate since the SEC first proposed changes in December 2019.
Amendments to the “accredited investor” definition add new categories of qualifying natural persons and entities.
The updated list of entities that may be eligible to participate in private offerings now includes certain American Indian and Alaska Native tribes, governmental bodies, funds and entities organized under the laws of foreign countries, that own investments in excess of $5,000,000 and were not formed for the purpose of investing in securities. Other entities, like registered investment advisers, have no asset requirements.
Limited liability companies (LLCs) with $5,000,000 in assets may now be “accredited,” as well as some SEC- and state-registered investment advisers and rural business investment companies (RBICs).
The Commission maintains the discretion to reevaluate and update eligibility. As such, excluded investors can seek the Commission’s consideration of additional certifications, designations or credentials as evidence of sophistication for an accredited investor status.
The SEC also broadened the definition of “qualified institutional buyer” in Rule 144A. This updated definition now includes LLCs and RBICs—if they have at least $100,000,000 in securities owned and invested. Accredited investors who meet the $100,000,000 threshold also meet the new qualified institutional buyer definition.
The SEC will continue to evaluate and update the credentials and certifications that qualify an individual as an “accredited investor.”
It is not clear exactly how far the SEC will expand the accredited investor definition, though there is a clear signal to expand investment participation in private markets.
The amendments and order become effective October 27, 2020, sixty (60) days after publication in the Federal Register.