On August 26, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to Rule 501(a) under the Securities Act of 1933 (the “Securities Act”), which defines the term “accredited investor” for purposes of the Regulation D “safe harbor” thereunder (the “Amended Rule”). Under the Amended Rule, a natural person will be an accredited investor based on his or her: (i) professional certifications or designations; (ii) credentials from an accredited educational institution; or (iii) status as a private fund’s “knowledgeable employee”. A natural person will also be able to aggregate his or her income or net worth with that of the person’s “spousal equivalent” in determining whether it meets financial thresholds set forth in the current accredited investor definition.1 The Amended Rule also adds “family offices” and their respective “family clients” as new categories of accredited investors, provided that they meet certain requirements. In addition, an entity’s status as an SEC-registered investment adviser, a state-registered investment adviser, an exempt reporting adviser or a rural business investment company will make it an accredited investor under the Amended Rule. The Amended Rule also adds a “catch-all” entity category intended to capture all entity types not currently included in the current accredited investor definition, as well as those that may be created in the future, provided that any such entity satisfies an “investments” test and was not formed for the specific purpose of acquiring the securities offered. The SEC also adopted amendments to other securities law rules that referenced the current accredited investor definition in Regulation D to conform those rules to the Amended Rule.
II. Amendments to Accredited Investor Definition
A. Natural Persons
Under the current accredited investor definition, with the exception of certain individuals affiliated with the issuer making the securities offering2, a natural person is required to satisfy a net worth test3 or an income test4 to be an accredited investor. The Amended Rule adds the following two categories of natural person accredited investors.
(1) Natural Persons Holding Professional Certifications and Designations or Other Credentials
Under the Amended Rule, “any natural person holding in good standing one or more certifications or designations or credentials from an accredited educational institution that the Commission has designated as qualifying an individual for accredited investor status” will be an accredited investor.5 In connection with adopting the Amended Rule, the SEC issued an order designating the following as its initial certifications, designations and credentials for these purposes: (i) the General Securities Representative license (Series 7); (ii) the Private Securities Offerings Representative license (Series 82); and (iii) the Licensed Investment Adviser Representative (Series 65). To comply with the “good standing” requirement, the individual must pass the required examination and maintain his or her license or registration, as applicable, in good standing.
(2) Knowledgeable Employees of Private Funds
Pursuant to the Amended Rule, any natural person who is a “knowledgeable employee” of a private fund6 offering or selling its securities will be an accredited investor in respect of his or her investments in that private fund.
Addition of the Term “Spousal Equivalent” to the Accredited Investor Definition
Under the current accredited investor definition, a natural person is permitted to aggregate his or her net worth or income, as applicable, with that of the person’s spouse in determining whether it satisfies the financial thresholds set forth in the Rule 501(a)(5) net worth test or the Rule 501(a)(6) income test. The Amended Rule permits a natural person to aggregate his or her net worth or income, as applicable, with that of the person’s “spousal equivalent” in determining whether it satisfies either of those tests.7 The term “spousal equivalent” is defined in the Amended Rule as a “cohabitant occupying a relationship generally equivalent to that of a spouse”.
B. Family Offices and Family Clients
The Amended Rule also adds “family offices” and their respective “family clients”8, as those terms are defined under the Investment Advisers Act of 1940 (the “Advisers Act”), as new categories of accredited investors, provided that they meet certain requirements described below.
Under the Amended Rule, a family office is an accredited investor if: (i) it has assets under management in excess of $5 million; (ii) it was not formed for the specific purpose of acquiring the securities offered; and (iii) its prospective investment is directed by a person who has such knowledge and experience in financial and business matters that the family office is capable of evaluating the merits and risks of the prospective investment.
Under the Amended Rule, a family client is also an accredited investor if the family client is: (i) a family client of a family office that is an accredited investor; and (ii) its prospective investment in the issuer is directed by a person at the family office for which it is a family client who has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the prospective investment.
The Amended Rule expands the existing list of entities that meet the definition of an accredited investor.9
SEC-Registered Investment Advisers, State-Registered Investment Advisers, Exempt Reporting Advisers and Rural Business Investment Companies
Under the Amended Rule, the following categories of entities are accredited investors under Rule 501(a)(1) solely as a result of their respective statuses: (i) SEC-registered investment advisers (including those that are sole proprietorships); (ii) state-registered investment advisers; (iii) exempt reporting advisers10; and (iv) rural business investment companies.11
Limited Liability Companies
The Amended Rule also codifies a longstanding SEC staff position12 that a limited liability company is an accredited investor if it: (i) has total assets in excess of $5 million; and (ii) was not formed for the purpose of acquiring the securities offered.
“Catch-All” Entity Category
The Amended Rule adds a “catch-all category” intended to capture all types of entities not currently included in the accredited investor definition, as well as entity types that may be created in the future. Specifically, any entity will be an accredited investor if it: (i) owns “investments”13 in excess of $5 million; and (ii) was not formed for the specific purpose of acquiring the securities offered.
III. Amendments to Other Securities Law Rules
The SEC also adopted amendments to several other securities law rules that referenced the current accredited investor definition to conform those other rules to the Amended Rule. In particular, the SEC adopted amendments to Rule 144A under the Securities Act14 to ensure that any entity that is an accredited investor under the Amended Rule is also a qualified institutional buyer (“QIB”) under Rule 144A to the extent such entity meets the $100 million in securities owned and invested threshold in Rule 144A(a)(1)(i).15 Rule 215 under the Securities Act, which is applicable to securities offerings made under Section 4(a)(5) of the Securities Act, was also amended to replace the existing accredited definition therein with a cross-reference to the Amended Rule to ensure that the accredited investor definition in both provisions is uniform. Moreover, Rule 163B under the Securities Act16 was amended to permit issuers to engage in test-the-waters communications with all entities that are accredited investors under the Amended Rule. Finally, Rule 15g-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), which exempts certain transactions by broker-dealers from disclosure requirements set forth in Rules 15g-2 through 15g-6 of the Exchange Act17 if the customer is an entity accredited investor, was amended to include all entity customers that are accredited investors under the Amended Rule.
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The Amended Rule will become effective 60 days after its publication in the Federal Register (the “Effective Date”). Accordingly, investment managers should consider updating the subscription agreements of their private fund clients that issue their securities utilizing Regulation D to reflect the expanded accredited investor definition on the Effective Date. If you have any questions concerning the foregoing, please contact your primary attorney in Seward & Kissel’s Investment Management Group.