Private companies seeking to raise capital by selling equity to investors must structure the raise so that it is not considered a public offering under the Securities Act of 1933 unless they are prepared to undergo the cost and expense of an IPO. The most commonly relied upon exemption from the public offering requirements is Securities and Exchange Commission Rule 506 of Regulation D which is a safe harbor under Securities Act Section 4(a)(2). There are two types of offerings under Rule 506: one which must be to all “accredited investors” and another that permits investors that are not accredited but imposes onerous information requirements on the issuer for non-accredited investors. As a result, a significant majority of offerings are limited to accredited investors. The theory behind the requirement is that accredited investors have significant assets and are in a better position to protect themselves and so the limitations and requirement imposed on offerings to accredited investors are less stringent.
But who is considered an accredited investor? Rule 501(a) of Regulation D defines who qualifies as an accredited investor. On Aug. 26, 2020, the SEC announced amendments to the accredited investor definition that, in the SEC’s words, “update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in [private] markets.” These updates include:
- Adding a new category to the definition that permits individuals to qualify as accredited investors based on certain professional certifications, initially holders in good standing of the Series 7, Series 65, and Series 82 securities licenses. These individuals qualify as accredited regardless of their personal net worth or income level. The SEC intends to evaluate and potentially add additional accredited investors categories in the future.
- Allowing “knowledgeable employees” of private funds (as defined in the Investment Company Act) to qualify as accredited investors for the purposes of investing in the fund.
- Historically, individuals have been able to qualify as accredited based on their personal net worth or income or joint net worth or income with a spouse. The amendment now allows “spousal equivalents” to qualify as accredited investors under the joint net worth or income thresholds. A “spousal equivalent” is defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse.”
- In addition to the changes applicable to individuals, the SEC clarified that limited liability companies with $5 million in assets and “family offices” with at least $5 million in assets under management may be accredited investors. The addition of LLCs to the list of qualified entities codifies prior SEC interpretation of Rule 501(a).
In connection with the announcement of the amendments, SEC Commissioner Elad L. Roisman stated, “wealth is a crude measure of a person’s ability to make financial decisions.” Although the long-standing asset and income tests were not revised, Commissioner Roisman indicated that the SEC has only taken a first step in adopting a more knowledge-based definition of who qualifies as accredited. The final rule will be effective 60 days after publication in the Federal Register.
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