2020 Changes to “Accredited Investor” Definition

On August 26, 2020, the SEC issued a press release generally highlighting amendments to Rule 501(a), Rule 215, and Rule 144A of the Securities Act of 1933 (the “Amendments”). According to the press release, these changes are an effort to simplify and improve exempt offerings by expanding the investment opportunities to other individuals and entities based on their professional knowledge or experience.

Formerly, an “accredited investor” was deemed an individual with “financial sophistication,” particularly a certain level of wealth (annual income of $200,000, or combined income with spouse of $300,000) or net worth (minimum of $1,000,000, with exclusion of primary residence value), as well as the ability to withstand the risk of investment loss.

However, in the summer of 2019, after years of evaluation, the SEC invited comments by the public on its Concept Release to assist the Commission with amending the definition. Now, in addition to the tests for income or net worth, an “accredited investor” may be an individual with professional knowledge, experience, or certifications, or certain approved entities, as follows:

1. According to the Amendments, an individual that holds certain Financial Industry Regulatory Authority, Inc. (FINRA) certifications or designations, such as the Licensed General Securities Representative (Series 7), Licensed Advisor Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82), may be considered an accredited investor. However, for this consideration, one must have passed the required examinations and maintain their license or registration in good standing. It is worth noting that the SEC left the door open for future additions of other certifications or designations that may qualify an individual as having the requisite professional knowledge.
2. If an individual is considered a “knowledgeable employee” of the fund, he or she may be considered an accredited investor. A knowledgeable employee, according to the Amendments, mirrors that of Rule 3c-5(a)(4) of the Investment Company Act, which includes trustees, directors, and advisory board members, or employees that have participated in the fund’s investment activities for a minimum of 12 months.
3. Registered Investment Advisors are no longer limited to the $5 million assets test under Rule 501(a)(3) to qualify as an accredited investor. The Amendments extend the accredited investor status to all SEC- and state-registered investment advisors, as well as exempt reporting advisors.
4. Rural business investment companies (RBICs), which ultimately create wealth and job opportunities in rural areas to promote economic growth, are now viewed similarly to small business investment companies (SBICs) since they share the same purpose of promoting capital formation. Because SBICs are already deemed accredited investors, the SEC found it necessary to extend the same qualification to RBICs under Rule 501(a)(1).
5. A limited liability company (LLC), so long as it meets the requirements of Rule 501(a)(3) and the asset test (specifically, has total assets in excess of $5 million and was not formed to acquire the securities being offered), is considered to have the financial sophistication necessary to qualify as an accredited investor.
6. Other entities meeting an investment-owned test, such as Indian tribes and governmental bodies and funds, were added as a new category to the definition. Similar to LLCs, these other entities must meet the requirements of Rule 501(a)(3), and own investments — as defined in Rule 2a51-1(b) under the Investment Company Act — that exceed $5 million and the entity was not formed specifically to acquire the securities being offered. According to the Amendments, this addition was to “capture all entity types” that were not previously included.
7. Certain family offices, as defined by the family office rule, and their family clients were added in the Amendments. To qualify, a family office (i) must have more than $5 million in assets under management; (ii) was not formed for the specific purpose of acquiring securities offered; and (iii) must have any prospective investment handled by an individual in the family office that has knowledge and experience in financial and business matters to properly assess the investment’s merits and risks. These same qualifications flow to any family clients that are directed to the prospective investment by the family office.

The Amendments further note that, although the financial thresholds for accredited investors were not modified, the term “spousal equivalent” has been recognized and added to the definition. Doing so allows both spouses and those cohabitants occupying a relationship to pool their finances to qualify as accredited investors.

In addition to the aforementioned changes provided in the Amendments, the SEC included LLCs and RBICs to Rule 144A as QIBs, so long as the entities hold at least $100 million in owned and invested securities.

The Amendments were effective as of December 8, 2020, according to the Final Rule.

While the amendments are trending in the right direction, it may not have a substantial impact on the private offering market. Moreover, several licensed or certified representatives may already qualify as an accredited investor due to their income or net worth. As the Commission identifies in its Final Rule, it “expect[s] the amount of capital invested by such newly eligible individual investors to have minimal effects on the private offering market generally,” but “may be significant in certain small offerings.” Nonetheless, the Amendments adequately expand the definition by recognizing the financial sophistication of individuals and entities that are involved in investment practices, in conjunction with those of a more robust net worth.