Finally, the SEC Modernizes the “Accredited Investor” Definition
Until now, to be eligible to invest in most private securities offerings, an investor must meet the longstanding definition of “accredited investor” which was tied to an investor’s net worth or income level. In changes adopted by the Securities and Exchange Commission (the “SEC”) on August 26, 2020, that definition now has been modernized to take into account an investor’s financial sophistication. This is an exciting development for individuals who previously were excluded from the venture capital markets because they lacked the high net worth or high income required to participate. Instead, the updated definition now makes room for individuals who have relevant investment knowledge and expertise but lack the wealth or income to meet the old test. This bodes well for people who historically have not participated in the wealth-creating world of VC investing, and savvy entrepreneurs like Serena Williams who are inviting new entrants, particularly women and people of color, to invest through her venture fund, Serena Ventures, as highlighted in her recent Twitter posts.
The specific amendments are summarized below, but one of them introduces the new term “spousal equivalent.” Previously, only married couples could pool their assets or income to qualify as a single “accreditor investor” unit. Under these amendments, unmarried couples may pool their assets for purposes of qualifying as an “accredited investor,” so long as the individuals are cohabitants occupying a relationship generally equivalent to that of spouses. If the unmarried couple meets this requirement, and they have at least an annual income of $200,000 or a $1 million net worth, they will qualify as an “accredited investor.” Although now marriage is available to LGBTQ couples, generally the rates of marriage in the United States have dropped from 9.8 marriages per 1,000 people in 1990 to 6.5 marriages per 1,000 people in 2018. As such, the concept of “spousal equivalent” will enable cohabitating unmarried couples to now be able to invest together.
Modernized “Accredited Investor” Definition
While the amendments are intended to modernize the “accredited investor” term as defined in Rule 501(d) of Regulation D, they also maintain investor protections by helping ensure that investors are able to analyze and bear the risk of their investments. The SEC also updated the definition of “qualified institutional buyer” under Rule 144A of the Securities Act.
Specifically, the amendments are as follows:
- Add a new category to the definition that permits natural persons to qualify as “accredited investors” based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the SEC may designate from time to time by order. Currently, these include holders in good standing of the Series 7, Series 65, and Series 82 licenses. The SEC has reserved the right to reevaluate or add the designated licenses.
- Include as “accredited investors,” with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund.
- Clarify that limited liability companies with $5 million in assets may be “accredited investors” and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify.
- Add a new category for any entity, including Native American 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.
- Add “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.
- Add the term “spousal equivalent” to the “accredited investor” definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.
Updated “Qualified Institutional Buyer” Definition
In addition, the SEC expanded the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition. The amendments also add to the list any institutional investors included in the “accredited investor” definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
Effective Date
These amendments become effective 60 days after they are published in the Federal Register, which should happen in the coming weeks. As the world finds its new normal in 2021 with hopefully the worst of the coronavirus behind us, it will be exciting to see the extent to which new investors will find avenues for wealth creation, which will further increase entrepreneurism.
To discuss the above topic, please contact Ara Babaian at ara@encorelaw.com, or any other Encore Law attorney.