October 21, 2021

Volume XI, Number 294

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SEC Modernizes “Accredited Investor” Definition

On August 26, 2020, the US Securities and Exchange Commission (the SEC or “Commission”) adopted amendments to the definition of “accredited investor” to add new categories of qualifying natural persons and entities and make certain other modifications to the definition. The amendments expand the categories of individuals who will qualify as accredited investors. The changes to the definition of “accredited investors” are significant in that they allow individuals and entities to participate in the capital markets as long as they have the requisite financial sophistication, knowledge and expertise needed to conduct meaningful investment analyses. We anticipate that the expansion of the “accredited investors” definition will promote capital formation, expand investment opportunities to more investors and allow such investors to improve the risk-return characteristics of their portfolios. The amendments will become effective 60 days after publication in the Federal Register.

IN DEPTH


The “accredited investor” definition is one of the principal tests for determining who is eligible to participate in private capital markets. Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to participate in investment opportunities that do not have the additional protections provided by registration under the Securities Act of 1933, as amended.

Specifically, the final amendments to the “accredited investor” definition add the following new categories of natural persons and entities that may qualify as accreditor investors:

  • Natural persons who have certain professional certifications and designations or other credentials as designated by the Commission (New Provision 501(a)(10)). In determining whether an individual qualifies for accredited investor status, the Commission will consider a nonexclusive list of attributes, including whether the certificate, designation or credential arises out of an examination or series of examinations administered by a self-regulatory organization or other industry body or is issued by an accredited educational institution. The Commission is adopting a good standing requirement, but is not requiring that the individual practice in the fields related to the certification or designation or that such individual has practiced for a minimum number of years. To assist members of the public, the professional certifications and designations and other credentials currently recognized by the Commission as satisfying the adopted criteria will be posted on the Commission’s website. The Commission will provide notice and an opportunity for public comment before issuing any final order with respect to any future designations of qualifying credentials.
  • Natural persons who are “knowledgeable employees” of private funds (New Provision 501(a)(11)). This category includes, among other persons, trustees and advisory board members, or persons serving in a similar capacity, of a Section 3(c)(1) or 3(c)(7) fund, as contemplated under the Investment Company Act of 1940, or an affiliated person of such a fund that oversees the fund’s investments, as well as employees or an affiliated person of such a fund who, in connection with their regular functions or duties, has participated in the investment activities of the fund for at least 12 months. The final amendments exclude employees performing solely clerical, secretarial or administrative functions.
  • SEC and state-registered investment advisors (including those that are sole proprietorships),exempt reporting advisors and advisors to private funds (Amended Rule 501(a)(1)). This category includes investment advisors exempt from registration as investment advisors under (y) Section 203(l) of the Investment Advisers Act because they are advisers solely to one or more venture capital funds, or (z) Rule 203(m)-1 of the Investment Advisers Act because they are advisers solely to private funds and have assets under management in the United States of less than $150 million. The SEC has included these advisors in the accredited investor definition because it considers them having the requisite financial sophistication needed to conduct meaningful investment analyses.
  • Rural business investment companies (RBICs) (Amended Rule 501(a)(1)). An RBIC is defined as a company that is approved by the Secretary of Agriculture and that has entered into a participation agreement with the Secretary. RBICs are similar to small business investment companies (SBICs), which are already considered accredited investors, as they are treated similarly to SBICs under federal securities laws and share a common purpose of promoting economic development and creating wealth and job opportunities in rural areas.
  • Limited liability companies that meet the requirements of Rule 501(a)(3) (Amended Rule 501(a)(3)). The amendments clarify that limited liability companies are accredited investors. Previously, Rule 501(a)(3) did not expressly include limited liability companies under the certain types of entities that qualify for accredited investor status if they have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities being offered.
  • Any entity owning “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered (New Provision 501(a)(9)). This catch-all category includes entities that were not historically included in the accredited investor definition, such as American Indian tribes, labor unions, governmental bodies and funds and entities organized under the laws of the foreign country. The amended rule focuses on the amount of investments owned by the entity to determine its accredited investor status rather than the nature of the entity itself, as long as the entity was not formed for the purpose of making the investment in question.
  • Certain “family offices” and “family clients of family offices” (New Provisions 501(a)(12) and 501(a)(13)) Under the amendments, a family office will be deemed accredited investors if it meets the following requirements: (i) has at least $5 million in assets under management; (ii) is not formed for the specific purpose of acquiring the securities offered; and (iii) provides that prospective investments are directed by a person who has such knowledge and experience in financial and business matters. Also, family clients of family offices will be considered accredited investors if their family office meets the requirements stated above and the prospective investment in the issuer is directed by such family office. The term “family clients” is defined under Rule 202(a)(11)(G)–1 under the Investment Advisers Act and generally consists of family members, former family members and certain key employees of the family office, as well as certain of their charitable organizations, trusts, and other types of entities.

Also, the final amendments now permit the income and wealth of “spousal equivalents” to be considered when determining a natural person’s accredited investor status. A spousal equivalent is defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.

Changes to “Test-the-Waters” Rule 163B. Finally, the Commission also amended Rule 163B to add some of the new categories of accredited investors to the list of persons and entities with whom issuers can engage in “test-the-waters” communications. The amendments allow an issuer to engage in “test-the-waters” communications with persons and entities that are, or that the issuer or persons authorized to act on its behalf reasonably believes are, accredited investors under (y) the new Rule 501(a)(9), which permits accredited investors to be entities of a type not listed in paragraphs Rules 501(a)(1), (a)(2), (a)(3), (a)(7) or (a)(8), that own investments in excess of $5 million and that were not formed for the specific purpose of acquiring the securities offered, and (z) the new Rule 501(a)(12), which includes family officers as accredited investors. Prior to the amendments, the “test-the-waters” rules permitted “test-the-waters” communications to prospective investors that are, or that the issuer reasonably believes are, qualified institutional buyers, as defined in Rule 144A, or institutions that are accredited investors, as defined in Rule 501(a)(1), (a)(2), (a)(3), (a)(7) or (a)(8). These changes to the Rule 163B maintain the consistency between Rule 163B and the emerging growth company “test-the-waters” rules under Section 5(d) under the Securities Act of 1933, in that institutional accredited investors under proposed Rules 501(a)(9) and (a)(12) would automatically fall within the scope of Section 5(d).

© 2021 McDermott Will & EmeryNational Law Review, Volume X, Number 241
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About this Author

Robert H. Cohen, Corporate Attorney with McDermott Will law firm
Partner

Robert H. Cohen is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s New York office.  He focuses his practice on transactional and securities work for a broad range of clients, including initial and follow-on public offerings, registered direct and PIPE financings, private placements, bridge financings, equity line and reverse mergers.

Bob has extensive experience in the areas of mergers and acquisitions, joint ventures, 1933 & 1944 Act representation and licensing and distribution arrangements...

212-547 5885
Thomas P. Conaghan, Mcdermott Will Emery law Firm,  (M&A), joint ventures, strategic investments, spin-offs,
Partner

Thomas P. Conaghan is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s Washington, D.C., office.  Tom represents both publicly held and closely held businesses, underwriters and other sources of capital, corporate boards and board committees and corporate executives.  He advises both U.S. and foreign-based public companies on issues relating to public and private offerings of securities, disclosure, periodic reporting, corporate governance, executive compensation, the rules of the New York Stock Exchange and the Nasdaq Stock Market and compliance with the...

202-756-8161
Partner

Gary Emmanuel is a partner in the law firm of McDermott Will & Emery and is based in the Firm’s New York office. He focuses his practice on corporate securities matters.

With over 15 years of experience, Gary represents both domestic and foreign companies that are navigating the process of capital raising including initial public offerings, registered direct offerings, follow-on offerings, private placements, PIPEs and bridge financings. Gary has worked extensively with biotechnology and other life science companies, both as company counsel...

212 547 5541
Partner

Ze’-ev D. Eiger focuses his practice on securities and capital markets for both foreign and domestic companies. He represents issuers, investment banks/financial intermediaries, and investors in financing transactions, including initial public offerings, follow-on offerings and private placements of equity and debt securities. Ze’-ev has extensive experience working with a wide range of issuers, including biotechnology/health care companies, technology companies, startups, real estate investment trusts (REITs), business development companies (BDCs) and closed and open-end funds.

Ze...

212-547-5470
Mark J. Mihanovic Corporate Finance Mergers & Acquisitions Attorney McDermott Will Emery Law Firm
Partner

Mark J. Mihanovic is a partner in the law firm of McDermott Will & Emery LLP.  Mark heads our Firm’s California corporate practice and serves as corporate liaison partner in the Firm’s strategic alliance with MWE China Law Offices based in Shanghai.  His practice is primarily focused in the areas of corporate finance and mergers and acquisitions involving companies in a broad range of industries, with a particular emphasis on technology, life science and health care companies.  Mark has served as lead counsel on behalf of issuers and underwriters in numerous public...

1 650 815 7438
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