On December 18, 2019, the U.S. Securities and Exchange Commission (the “SEC”) issued a press release highlighting proposed amendments to the definition of an “accredited investor” under the Securities Act of 1933 (the “Act”). We expect private fund managers to embrace the proposed changes, as the amendments seek to permit more investors to participate in private capital markets by including new categories of qualifying natural persons and entities and solidifying previous interpretive positions held by the SEC. Below is a short summary of the notable proposed additions to the definition. The SEC’s full press release and the complete proposal can be found here.
- Professional Certificates and Knowledgeable Employees of a Fund
The proposed definition will add two new categories applicable to individual investors. First, the new definition will allow natural persons who hold professional certifications to be considered accredited investors regardless of their financial condition. The SEC states in the proposal that it expects this category will initially include holders of Series 7, 65, or 82 licenses but mentions holders of other degrees and certifications (CFA, CPA, MBA) as possible inclusions as well.
Second, the new definition will include a specific carve out for “knowledgeable employees” of a private fund. The carve out will be similar to the current category for directors, executive officers, or general partners of the issuer but will apply more broadly to include knowledgeable employees as currently defined in Rule 3c-5 of the Act.
- Registered Investment Advisors, RBICs, and LLCs
While the current definition of accredited investor includes various entity types, the SEC is seeking to add three additional entity types that it feels are sophisticated enough to be considered accredited. Specifically, the SEC is proposing to add state and SEC registered investment advisers, approved rural business investment companies (as defined in the Consolidated Farm and Rural Development Act), and certain limited liability companies.
The inclusion of certain LLCs is of particular note because the current definition does not specifically refer to LLCs. Under the new definition, the SEC will add LLCs to the list of entities that are considered accredited as long as they have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered.
- Certain Family Offices and Family Clients
The SEC is also proposing a new category of accredited investors that includes any “family office” with at least $5 million in assets under management and its “family clients,” as those terms are defined under the Advisers Act. The SEC is also proposing that the family office must not be formed for the specific purpose of acquiring the securities offered and that the family office be directed by a person with the requisite knowledge and experience in financial and business matters to ensure the family office is capable of evaluating the merits and risks of the prospective investment.
As justification for the addition, the SEC believes that these family offices have the minimum amount of assets under management to sustain the risk of loss and that the additional requirements will safeguard against improper reliance. The SEC generally expects all family offices to be accredited under the new definition.
- Entities Owning at Least $5 Million in Investments
In addition to including the enumerated entities above, the SEC is also proposing a catch-all category that will allow any entity owning investments in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered to be deemed accredited. This new category is meant to include all existing entity forms not already contemplated by the current definition, such as Indian tribes or governmental bodies.
- Codification of SEC Interpretations of the Current Rule
As part of the proposed definition, the SEC is codifying certain existing interpretations of the current definition. Of note, the SEC will codify two important interpretations applying to entities owned solely by accredited investors and individuals pooling combining finances with spousal equivalents.
The current definition of accredited investor includes any entity in which all the equity owners are accredited investors. However, the definition does not state whether one should look through any underlying entities that are not natural persons. Consistent with the SEC’s existing interpretation of the current definition, the proposed definition specifically states that one may look through any equity owners that are entities to the ultimate natural person owners.
The current definition allows “spouses” to pool together their finances to meet the relevant thresholds. However, the definition does not explicitly extend to spousal equivalents such as domestic partnerships or civil unions. Consistent with its current interpretation, the SEC is proposing this amendment because it sees no reason to distinguish between these types of relationships and believes that the new definition will remove any unnecessary barriers to investment opportunities for spousal equivalents.