On August 26, 2020, the U.S. Securities and Exchange Commission adopted final rules to implement some long-needed reforms by way of adopting a modernized definition of “accredited investor,” in addition to adopting conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act. These amendments will become effective 60 days following the publication in the Federal Register.

Note: An accredited investor is a person or a business entity who is allowed to deal in securities that may not be registered the U.S. Securities and Exchange Commission, and who has a special status under financial regulation laws. Generally speaking, an individual is an accredited investor if they have an annual income exceeding $200,000 ($300,000 for joint incomes) in each of the last two years or who has a net worth (not including his or her home) exceeding $1,000,000.

Updates to Accredited Investor Determinations:

The amendments update and improve the definition by creating additional classifications to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets. The amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth.  With the exception of directors, executive officers, and general partners, the prior definition only allowed for the use of income and net worth as financial measures to determine a person’s financial sophistication. Now, “knowledgeable employees” of a fund, can be deemed “accredited investors” in respect to investments in the private fund for which they work.

Unfortunately, those hoping for a loosening of the paternalistic restrictions on the definition of accredited investor will be sorely disappointed as the changes are a mere trimming around the edges. Potential investors who do not meet the income, net worth, or licensing thresholds won’t be able to invest in private offerings because the government deems the investments too risky – but hey, those same investors can go down to the local 7-11 and play the lottery to their heart’s content.

Updates For Private Individuals:

The trimming around the edges recognizes the consequences of today’s culture wars and shifts from a husband-wife pooling standard to a “spousal equivalent” standard in calculating the pooled income/net worth for determining whether an investor has met the necessary accredited investor threshold.

Most relevant to private individuals and where many had speculated significant changes might be made is the expansion of accredited investor to include a non-income/net worth category of qualification. Unfortunately for industry professionals, the SEC chose not to expand the accredited investor definition to include a sophistication-based category. Such a category might have included CPAs, MBAs, attorneys, etc. – the very deal professionals who are involved in assembling and advising the private investments they are prohibited from investing in unless they meet the income/net-worth threshold. Instead, the SEC expanded the definition to only include registered securities representatives (Series 7, 65, and 82) and registered investment advisers.

Expansion of Qualifying Entities:

The amendments allow for an expanded list of entities that may qualify as accredited investors by allowing any entity that meets an investments test to qualify. This includes the creation of a new category for any entity 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. This amendment is also inclusive of entities organized under the laws of foreign countries, Indian tribes, funds, and governmental bodies. The amendments further clarify that limited liability companies with $5 million in assets may be accredited investors.

Additionally, “family offices” with at least $5 million in assets under management, along with their “family clients” (as defined under the Investment Advisers Act) are also now recognized as accredited investors.

Conclusion:

Thus, while there is reason to be thankful for the limited clean-up performed by the SEC, the proposed regulations fall far short of what many industry professionals had hoped might occur – namely the loosening of the definition of accredited investor to allow more individuals to participate in some of the best investment opportunities in today’s market and expanding the amount of capital available to further drive growth in the American and world economy.

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This blog was written by Hunter Business Law Attorney David Kronenfeld.

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