January 06, 2020 | By Patrick T. McCloskey
On December 18, 2019, the Securities Exchange Commission (SEC) proposed certain amendments to the definition of “accredited investor” under Rule 501(a) under the Securities Act of 1933, as amended (the “Securities Act”). The proposed changes are meant to broaden the universe of investors eligible to participate in private offerings exempt from registration under the Securities Act, such as the exemptions under Rule 506(b) and Rule 506(c). The SEC sought input on this issue in its July 2019 concept release to harmonize the exemptions from registration under the Securities Act.
Among other things, the proposed amendments would:
The proposed amendments include a note to Rule 501(a)(5) to clarify (1) that the reference to “joint net worth” in that paragraph includes the aggregate net worth of an investor together with his or her spouse or spousal equivalent, and (2) neither the assets included in the calculation of joint net worth nor the securities to be acquired in the offering at issue need be owned or purchased jointly. The SEC noted that this position is consistent with current interpretive guidance.3
Interestingly, although the SEC proposed to specifically include LLCs to the list of entities in Rule 501(a)(3) (i.e. assets exceeding $5.0 million not formed for the specific purpose of acquiring the securities offered), they did not deem it necessary to categorically add LLC managers to Rule 501(a)(4), which provides that directors, executive officers and general partners of the issuer are accredited investors by virtue of their positions, or Rule 501(f), which is the definition of executive officer for purposes of Rule 501(a)(4). The rationale from the proposing release is that managers of LLC issuers are likely “executive officers” due to their policy making functions, and, as such, the change was unnecessary.
Since the proposed Rule 501(a)(9) would apply to all entities, trusts not formed for the specific purpose of acquiring the securities offered with investments of at least $5.0 million would not need to have a sophisticated person make investment decisions in order to qualified as an accredited investor. This additional requirement is currently a prerequisite in the accredited investor category set forth in Rule 501(a)(7) (the current category of accredited investor specifically applicable to trusts), and the SEC specifically sought feedback on whether this anomaly was appropriate.
The SEC staff is also proposing to add a note to Rule 501(a)(8) (the category that renders an entity an accredited investor by virtue of each of its equity owners being an accredited investor) to clarify that an entity may “look-through” its equity owners that are entities and, if such indirect ownership renders the equity holder entity accredited, then the entity at issue would likewise be deemed to be accredited.4
The SEC declined to adjust the dollar amounts in the net worth ($1,000,000) and income ($200,000 individually; $300,000 jointly) thresholds for natural persons. Although the proposing release acknowledged that these amounts had not been modified since Regulation D was adopted in 1982 (and the inflation-adjusted amounts would be $13,0000,000 (net worth), $520,000 (individual income) and $632,000 (joint income) in 2019 dollars, the SEC was reluctant to restrict, rather than expand, the existing universe of accredited investors, citing the abundance of information about private issuers available through social media, lack of abuse in Regulation D offerings and the potential disruptive effect on capital raising if the pool of accredited investors were to be reduced. The SEC did note that it is seeking input on whether these financial thresholds should be adjusted in the future (on an inflation-adjusted basis or otherwise).
Without floating a specific proposal, the SEC sought input on whether it should implement an additional category of accredited investor for someone who is advised about the merits of a Regulation D offering by a fiduciary, such as a registered investment adviser or broker-dealer.
The SEC proposed conforming amendments to Rule 163B, which expanded permissive testing-the-water communications with Qualified Institutional Buyers (QIBs) and Institutional Accredited Investors (IAIs), so that the expanded categories of accredited investor will be picked up by Rule 163B. Similarly, the proposal would also include conforming amendments to Rule 15g-1(b), the exception to the broker-dealer disclosure requirements for “penny stocks”, so that the reference to institutional accredited investor in that rule reflects the expanded categories contemplated by the proposal.
The proposed amendments would also provide that institutional accredited investors under Rule 501(a) (as expanded after giving effect to the proposed amendments), be QIBs under Rule 144A to the extent they satisfy the applicable $100 million threshold.
The proposal would also amend Rule 215 so that the definition of accredited investor in that rule would be the same as the definition included in Rule 501(a), as modified (currently the accredited investor definition in Rule 215 is similar, but not identical to, Rule 501(a)).
The proposed amendments are subject to a 60-day public comment period.
The entire proposing release is available here.
1 This is more of a clarification since the SEC staff had previously published interpretive guidance that LLCs satisfying the applicable criteria would be considered accredited investors under Rule 501(a)(3). See CD&I 255.05 (January 26, 1999); https://www.sec.gov/divisions/corpfin/guidance/
securitiesactrules-interps.htm (citing the Wolf, Block, Schorr and Solis-Cohen No Action Letter (December 11, 1996)).
2 Although the language in the proposing release states that “at least $5.0 million of assets under management” is the applicable threshold for family offices, the text of the new proposed Rule 501(a)(12) states “assets under management in excess of $5,000,000.” Presumably this will be clarified in the adopting release (assuming the amendments are in fact adopted).
3 See SEC Staff CD&I 255.11 (January 26, 2009): https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm
4 This is another position that is currently supported by interpretive guidance previously provided by the SEC staff. See SEC Staff CD&I 255.06 (January 26, 2009) https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm