The Securities and Exchange Commission (“SEC”) recently expanded which individuals and entities can participate in private exempt offerings under Regulation D by broadening the current definition of “accredited investor.”
The new definition of “accredited investor,” a definition that has not been changed since 1988, modernizes prior requirements and adds a new qualitative classification to what had been qualitative wealth or income tests to properly reflect current investment trends. In explaining the changes, SEC Chairman Jay Clayton said that “individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks” in exempt offerings should fall within the definition of an accredited investor.
Other individuals who can now participate in exempt offerings due to the expansion of the definition include “knowledgeable employees” (as defined in Rule 3c-5(a)(4) of the Investment Company Act of 1940 (the “Investment Company Act”)). Knowledgeable employees are defined in the Investment Company Act as (a) directors, officers, trustees, general partners, advisory board members or persons serving in a similar capacity of a private fund or an “affiliated management person”, and (b) an employee or affiliated management person of a private fund whose regular functions or duties includes participating in investment activities of a private fund or investment companies, and such activities are managed by the affiliated management person. An employee shall only be considered a “knowledgeable employee” if his or her participation in investment activities has been a function or duty of such employee for at least 12 months.
The SEC also included registered investment advisers in the expanded definition, as these advisers are regarded as possessing the financial sophistication to analyze certain investments. Because of this, the amendment deems any state or federally registered investment adviser as an accredited investor. Exempt reporting advisers are included in this expanded definition as well.
Individuals who have certain professional certifications administered by FINRA, such as the Licensed General Securities Representative (Series 7), the Licensed Investment Adviser Representative (Series 65), and the Licensed Private Securities Offerings Representative (Series 82) are now also deemed to be financially sophisticated and considered an accredited investor. The amendment also provides a list of attributes that would be considered by the SEC in determining what other professional certificates or credentials from an “accredited educational institution” would qualify an individual to be considered an accredited investor.
Similar to the prior definition of “accredited investor,” which primarily focused on certain income level or net worth tests, the amendment now includes any entity owning “investments” (as defined in Rule 2a51-1(b) of the Investment Company Act) of more than $5 million that is not formed specifically to acquire securities to be considered an accredited investor. Family offices that have at least $5 million in assets under management and whose proposed investments are directed by an individual with financial and business experience are now considered an accredited investor as well.
Other updates include adding limited liability companies to the types of entities with $5 million in assets to the types of entities that qualify as an accredited investors and adding couples in domestic partnerships to what were formally spousal wealth and income tests.
Issuers conducting private offerings will need to take reasonable steps to confirm the suitability of participants in the offering. For example, a Rule 506(b) offering allows for an unlimited number of accredited investors and up to 35 non-accredited investors, and such non-accredited investor (or together with their purchaser representative) must be a sophisticated investor to participate in the exempt offering.
These amendments will become effective sixty days after publication in the Federal Register. For more information regarding the SEC’s amendment to the definition, please see the Final Rule here.
Matthew Misichko is an associate in Thompson Coburn’s corporate and securities practice.
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