SEC Proposes to Expand and Update Accredited Investor and Qualified Institutional Buyer Definitions

The Securities and Exchange Commission (SEC) has approved proposed amendments to the definitions of “accredited investor” and “qualified institutional buyer” (QIB). If approved, the proposed amendments would expand investor access to private capital markets by adding new categories of natural persons and entities that may qualify as accredited investors or QIBs. The proposed amendments are subject to public comment for 60 days after publication in the Federal Register.

The SEC expects that the proposed amendments will expand the pool of accredited investors and QIBs. The SEC also expects that this expansion will improve the ability of companies to raise capital in exempt markets and reduce competition among companies for investors, thereby reducing the cost of capital and facilitating expanded small business capital formation. The proposed amendments would also permit companies to engage in test-the-waters communications with a larger set of investors in registered offerings.

The SEC has published a number of reports and reviews of the definition of accredited investor and related exempt offering matters in recent years, including most recently a concept release seeking comments on possible changes in the exempt offering framework under the Securities Act. The proposed amendments are based on public comments on the concept release and recommendations from the SEC’s Small Business Capital Formation Advisory Committee, the SEC’s Investor Advisory Committee and the SEC Government-Business Forum on Small Business Capital Formation.

ACCREDITED INVESTOR DEFINITION

Accredited investor is defined in Rule 501(a) of Regulation D. The definition is intended to identify investors who, because of their financial sophistication and ability to sustain the risk of investment losses, do not need the protections of the registration process for public offerings under the Securities Act of 1933. Importantly, accredited investors can invest in private offerings under Rules 506(b) and 506(c), which has become a very significant capital market, especially for start-up companies. The proposed amendments would not change the current $200,000 individual income and $1 million net worth thresholds established by the SEC in 1982 or the $300,000 joint income threshold established in 1988, and the proposed amendments would not index these thresholds to reflect inflation.

The proposed amendments would make the following changes and updates to the definition of accredited investor:

• permit natural persons to qualify as accredited investors based on specified professional certifications, designations or credentials from an accredited educational institution designated by an SEC order, which the SEC expects would include persons holding a Series 7, 65 or 82 FINRA license;
• permit natural persons who qualify as a “knowledgeable employee” of a private fund to invest in the fund;
• expand the current list of entities that may qualify as accredited investors to include limited liability companies (LLCs) that meet certain conditions, registered investment advisers, and rural business investment companies (RBICs);
• add a new category for any entity, including Indian tribes, 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;
• add a new category for certain “family offices” with at least $5 million in assets under management, and their “family clients,” as each term is defined under the Investment Advisers Act; and
• add the term “spousal equivalent” to the accredited investor definition and related note, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

QUALIFIED INSTITUTIONAL INVESTOR DEFINITION

The proposed amendments to the definition of QIB in Rule 144A would make the following changes:

• add LLCs and RBICs to the types of entities that are eligible for QIB status if they meet the $100 million in securities owned and investment threshold in the Rule 144A definition; and
• add a “catch-all” category that would permit entities that are “institutional accredited investors” (as defined in Rule 501(a)) but are not one of the categories of entities currently included in the definition of QIB to qualify as QIBs if they satisfy the $100 million threshold.