SEC Revises Definition of Accredited Investor

September 3, 2020

On August 26, 2020, the Securities and Exchange Commission (the “SEC”) amended the definition of “accredited investor” as defined under Rule 501 of Regulation D of the Securities Act of 1933, as amended (the “Securities Act”).  This new definition provides for additional categories of investors who are deemed to have the knowledge and expertise to participate in private offerings.   Up until the amendment, the definition of “accredited investor” had not changed significantly since it was originally adopted in 1982.

Accredited investors are deemed to have the financial sophistication necessary to evaluate a private investment opportunity and the financial ability to bear the risk of losing their investment.

The definition of “accredited investor” has generally included:

  1. Any individual whose net worth is over $1 million (excluding personal residence);
  2. Any individual whose income in each of the two most recent years was over $200,000 individually or $300,000 with their spouse and who reasonably expects to reach the same level of income in the current year;
  3. Any entity in which all the individual owners are accredited investors; and
  4. Certain entities with assets in excess of $5 million.

By way of background, the Securities Act requires that all offerings and sales of securities must either be registered by the filing of a registration statement with the SEC or be exempt from registration.  The most widely used exemption from registration by issuers raising capital is Rule 506(b) under Regulation D which allows issuers to raise an unlimited amount of a capital from an unlimited number of “accredited investors” through the offering and sale of securities if the offers are made without general solicitation or advertising, and the sales are made to no more than 35 non-accredited investors.  Issuers prefer to limit their offerings to accredited investors because otherwise the disclosure requirements are significantly greater.

In the recent revisions, the SEC expanded on the definition of “accredited investor” by adding, among other things:

  1. A new category that permits individuals to qualify as accredited investors based on certain professional certifications, designations or credentials issued by an accredited educational institution, which the SEC may designate from time to time.  The initial list includes holders in good standing of the Series 7, Series 65 and Series 82 licenses.
  2. With respect to investments in a private fund, individuals who are “knowledgeable employees” of the fund, generally defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940 to include executive officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity.
  3. SEC and state-registered investment advisers, and exempt reporting advisers;
  4. A clarification that limited liability companies (LLCs) with $5 million in assets may be accredited investors;
  5. A new category for any entities, including Indian tribes, governmental bodies, funds and entities organized under the laws of foreign countries, that own investments, as defined under Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that were not formed for the specific purpose of investing in the securities offered;
  6. Family offices with at least $5 million in assets under management and their family clients, as each is defined under the Investment Advisers Act;
  7. The term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their joint net worth or income for purposes of meeting the net worth or income tests set forth under the “accredited investor” definition.  A spousal equivalent is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.

These amendments were announced on August 26, 2020 and will take effect 60 days after publication in the Federal Register.   Issuers (including privately held companies, private equity, venture capital and hedge funds) of securities in private offerings will need to update their accredited investor questionnaires for future offerings.  Also, issuers should review the representations and warranties as to accredited investor status in subscription agreements and stock purchase agreements and other related M&A and securities documents to address the new amendments.

This article is for informational purposes only and is not intended to be legal advice. If you have any questions on the above, please reach out to Jason Schneider at Schneider Law Group at (919) 324-3599 or at jschneider@schneiderlawgroup.com.

Schneider Law Group is a business boutique law firm primarily focused on general corporate, M&A, securities, and tax strategy for growth-oriented businesses.  For more information, please visit www.schneiderlawgroup.com.