Posted in Business Attorney, Business Law, Corporate Attorney, Corporate Law, Investments, SEC (Securities and Exchange Commission), Securities, Small Business
SEC Expands Definitions of Accredited Investor and QIB, Widening Access to Private Offerings
If you have ever raised money as a startup, done private securities deals, raised money for private equity, or done other similar private securities market activities, you know how important the “Accredited Investor” standard is. HINT: if you want to get to exactly what the changes were, then please skip to Part 3 In the United States, the basic rule is that every offering of securities must be either registered with the Securities and Exchange Commission (SEC) or fall under an exemption from registration. Those exemptions generally have restrictions on (i) the amount that may be raised, (ii) the solicitation that may be done, and/or (iii) who may participate. Most relevant to the third of these considerations – who may participate – is the “Accredited Investor” standard set forth in Rule 215 and Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended (the 1933 Act), which flows through several of the other exemptions under the 1933 Act. This is very relevant because the process of filing a registration statement in the United States is very expensive, and the price of simply being a public company is also very high. In extreme summary, the basic idea behind the “Accredited Investor” standard is to allow sophisticated individuals who can “fend for themselves” to invest in securities not registered with the SEC (despite the expense to the company of said registration and compliance). While the goal behind this structure of exemptions for private offerings is to prevent securities fraud or abusive practices from taking advantage of the public at large (at which goal most would agree it has generally succeeded), this structure has received some criticism as sequestering the best, juiciest opportunities (exempt private securities offerings) for those who are already rich. And there’s probably a lot of truth to that criticism – several trillion dollars worth of truth, in fact; the SEC estimates that in 2019 issuers raised approximately 25% more funding through Regulation D exempt private securities offerings than through registered securities offerings open to the public ($1.56 Trillion vs. $1.2 Trillion). On August 26, 2020, the SEC took steps to address this by putting forward amendments to expand the definition of “Accredited Investor” found in Rule 215 and Rule 501(a). The amendments will open the doors for new people to qualify as “Accredited Investors” on the basis of their professional skills and knowledge, certificates, and experience, as well as for entities to qualify not on the basis of an asset test, but on the basis of an investment test. With the new expansion of this definition of Accredited Investor, SEC also expanded the definition of the qualified institutional buyer (QIB) in Rule 144 (A) under the 1933 Act. These amendments become effective 60 days after their publication. 1. Historical Background & The Original Definition As noted above, under the Rules promulgated under the 1933 Act, Accredited Investors and QIBs can participate in investment opportunities that are not available to the general public. These private investment opportunities generally involve more risk, as well as more potential upside (for example, private companies, private equity, hedge funds, and venture capital). The SEC has been considering changes to the accredited investor structure for quite some time. The criteria for being an “Accredited Investor” have not changed much since 1982. The previous definition, set forth in Rule 501 of Regulation D, was (again, in extreme summary):
- Individual with annual income above $200,000 ($300,000 with spouse) and expectation of maintaining the same income;
- Individual with net worth of over $1 million, exclusive of primary residence (individually or with spouse);
- Entity with assets above $5 million not formed for the express purpose of making the investment;
- Certain affiliates of an issuer (e.g. executive officers) may be considered accredited with respect to that issuer.
- In December 2015, A staff report from the SEC evaluated the history of accredited investor definition.
- In June 2019, the SEC issued a concept regarding it, “Solicited public comment on ways to simplify, harmonize and improve the exempt offering framework under the Securities Act”.
- In December 2019, the SEC suggested new rules to amend the definition to collect capital and expand the investment opportunities along with investor protection.
- In 2014 the Investor Advisory Committee of the SEC met to discuss updating the definition of an Accreddited Investor
- Adding as AI those individuals who qualify based on professional certifications, designations, or credentials as designated by the SEC from time to time (by order)
- Simultaneously with the foregoing, issuing an order that holders in good standing of Series 7, Series 65, and Series 82 licenses qualify as AIs under (1);
- An “invitation” for members of the public to propose to the SEC other professional certifications, designations, or credentials that they believe should qualify the holders thereof as AIs by order;
- Adding as “accredited investors” with respect to investments in a particular private fund the individual employees of the private fund who are “knowledgeable employees” of the fund
- Clarify that the following may qualify as AIs
- LLCs with >$5M that otherwise satisfy the definition of AI
- State-registered or SEC-registered investment advisers (section 203 Investment Advisers Act)
- exempt reporting advisers
- rural business investment companies (RBICs)
- Add a new category of AI for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “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;
- Include as AIs “family offices” with at least $5M in AUM and their “family clients” not specifically formed for the purpose of acquiring the offered securities, etc (as defined in the Investment Advisers Act; for more detail, see Rule 202(a)(11)(G)-1); and
- Add “spousal equivalent” to the AI definition, to permit spousal equivalents to permit their assets to qualify as AIs;
- Insurance Companies under the Securities Act of 1933
- Investment Companies under the Investment Company Act of 1940
- Small Business Investment Companies under the Small Business Investment Act of 1958
- Certain public employee benefit plans
- Certain trust funds
- Business Development Companies under the Investment Advisers Act of 1940
- Certain 501(c)(3) organizations
- Investment Advisers registered under the Investment Advisers Act of 1940