Doss Alerts

Attention fund managers and capital raisers for private offerings!  Your pool of potential investors just got much larger.  On August 26, 2020, the Securities and Exchange Commission (“SEC”) approved “Amendments” to the definition of “accredited investor.”  This definition is a key component of several exemptions from Securities Act registration, including Rules 506(b) and 506(c) of Regulation D, and plays an important role in other federal and state securities law contexts.  Qualifying as an accredited investor is significant because accredited investors may participate in investment opportunities that are generally not available to non-accredited investors, including certain investments in private companies and offerings by mortgage pools, REITs, real estate asset funds, hedge funds, private equity funds, and venture capital funds.

Participation in most private capital market deals generally requires, at a minimum, being an accredited investor.  The Amendments will allow more investors to participate in private offerings by adding new categories of individuals who may qualify as accredited investors based on their professional knowledge, experience or certifications.  The Amendments also expand the list of entities that may qualify as accredited investors by, among other things, allowing any entity that meets an investment test, rather than an asset test, to qualify.  To conform with the updated accredited investor definition, the SEC also expanded the definition of “qualified institutional buyer” (“QIB”) in Rule 144A under the Securities Act.

The Amendments can be found HERE, and become effective 60 days after publication in the Federal Register.

SEC Chairman Jay Clayton said, “for the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication…  I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations that may qualify to participate in certain private offerings.”

The SEC stated that the Amendments to the final rule are part of its “ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.”

SEC Commissioner Hester Peirce tweeted, “Americans shouldn’t have to ask the SEC for permission to invest, but today’s accredited investor rule at least offers people a path to ask permission based on their education, rather than simply telling them ‘no, unless you’re rich.’”

In the case of individuals, the SEC stated that “the previous rule used wealth – in the form of a certain level of income or net worth – as a proxy for financial sophistication…  We do not believe wealth should be the sole means of establishing financial sophistication of an individual for purposes of the accredited investor definition.  Rather, the characteristics of an investor contemplated by the definition can be demonstrated in a variety of ways.”

Pursuant to the SEC press release, the Amendments will revise Rule 501(a), Rule 215 and Rule 144A of the Securities Act of 1933.

Rule 501(a)

The Amendments to the accredited investor definition in Rule 501(a):

* 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 Commission may designate from time to time by order. In conjunction with the adoption of the Amendments, the Commission designated by order holders in good standing of the Series 7 [Licensed General Securities Representative], Series 65 [Licensed Investment Adviser Representative] and Series 82 [Licensed Private Securities Offerings Representative] licenses as qualifying natural persons. This approach provides the Commission with flexibility to reevaluate or add certifications, designations or credentials in the future.  Members of the public may wish to propose for the Commission’s consideration of additional certifications, designations or credentials that satisfy the attributes set out in the new rule;

* 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 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;

* 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; and

* 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.

 Rule 215

The amendment to Rule 215 replaces the existing definition with a cross reference to the definition in Rule 501(a).

Rule 144A

The Amendments expand 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.

The Commission also adopted conforming Amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.

The Upshot

The intention of the Amendments is to more successfully identify institutional and individual investors that have the knowledge and expertise to participate in private capital markets.  The Amendments also expand and update the list of entities that may qualify for accredited investor status, including tribal governments and other organizations under the “catch-all” category based on investments (instead of assets).

Fund managers should consider updating their offering, subscription and other investor application materials to account for the new accredited investor categories, either before raising capital for their next fund, and/or in order to accept new accredited investor subscribers into an existing open-end structured fund.

Doss Law, LLP creates mortgage pools, REITs, real estate asset funds.  We are the largest mortgage pool creator in California, and we have helped create some of the largest funds that have been operating for over 20 years.  Prudent legal advice comes from experience.  We have over 42 years of it.

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