BizTech Law Blog

SEC Expands Accredited Investor Definition to Include Sophisticated Investors, Others

On August 26, 2020 the Securities and Exchange Commission (SEC) adopted amendments to Rule 501(a) of the Securities Act that expand the definition of “accredited investor” to include additional categories of investors who may invest in unregistered private offerings. This amendment is intended to provide greater access to private investment markets. The amendments become effective 60 days after the new rule is published in the Federal Register.

Sophisticated Investors, Others Now Qualify

Before the adoption of this amendment, only individuals who met the net worth or income tests could be considered an accredited investor. The net worth test required investors to have a net worth of at least $1,000,000, excluding the value of the primary residence, and applies equally to individuals or married couples. The income test is met by individuals with an annual income of $200,000 (or $300,000 for married couples) in each of the last two years.

In addition to individuals that meet the above test, certain entities, including banks, investment broker-dealers, insurance companies, entities whose owners are accredited investors, and trusts with greater than $5 million in assets, are considered accredited investors.

The amended rule expands the definition of an accredited investor to include those described above and to now include:

• Individuals who have certain professional certifications, designations, or other credentials issued by an accredited education institution, which the SEC may designate from time to time.
  • In coordination with this new category, the SEC specifically designated 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.
• Individuals who are knowledgeable employees of a private fund;
• Limited Liability Companies with $5 million or more in assets that were not formed for the specific purpose of investing in the securities offered;
• Any entity that owns $5 million or more in “investments” as defined by Rule 2a51-1(b) of the Investment Company Act and that was not formed for the specific purpose of investing in the securities offered;
• Family offices with at least $5 million in assets under management and their “family clients” as defined under the Investment Advisers Act; and
• Individuals whose “spousal equivalent” meets the income and net worth test.

The Importance of Accredited Investors

Offers and sales of securities must be registered with the SEC under the Securities Act of 1933 (the Securities Act) unless an exemption from registration applies. Registration of a securities offering can be an expensive and time-consuming project, particularly for private companies (those that have not already conducted a registered initial public offering and are not otherwise already required to file reports with the SEC). Accordingly, most securities offerings are conducted through exemptions from registration. The “accredited investor” definition is important because several exemptions from registration require all investors in the offering to be accredited investors.

Companies can use registration exemptions to raise unlimited sums of money without ever going public. As a result, many companies, especially tech companies are raising significant capital while staying private longer. For instance, Uber remained private for nearly 10 years, only going public in 2019 – long after it received a billion dollar valuation.

Key Takeaways and Practical Effects

• According to the SEC, “the amendments update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.”
• Issuers of securities in private offerings will need to update their accredited investor and Qualified Institutional Buyer questionnaires for future offerings. This includes privately held companies, private equity, venture capital and hedge funds.
• Representations and warranties as to accredited investor status in subscription agreements, stock purchase agreements, and some merger and acquisition transactions will need to be updated to address the new amendments.

For questions related to these amendments or this communication, please contact:

• Taylor Gast  | 517.371.8238 | tgast@fosterswift.com

For help navigating the complicated rules surrounding securities law, please contact your Foster Swift attorney or a member of our Business & Tax Practice Group.

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