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SEC Modernizes and Expands the Definition of “Accredited Investor”

Many investments are open to anyone. For example, if you open a brokerage account, you can invest in publicly-traded stocks without qualifying as a special type of investor.

In the private world of investment, however, many investments are not available to the general public. Specific guidelines separate “accredited investors” from the general investing public.

You cannot elect simply to invest in a hedge fund or other private funds. Other deals, such as most private-equity investments, venture capital funds, and private equity and crowdfunded real estate investment deals, are off-limits to the general public, regardless of how much you may have available to invest.

To participate in these types of investments, as well as others that do not to adhere to the SEC registration requirements, you will need to be an accredited investor.

Companies often may choose to reduce expenses by foregoing registration and offering securities directly to the “accredited investor” class of buyer in a “private placement.” Because accreditation is not a formal process, its legal definition is intended to serve as guidance for the sellers of these securities, who are legally responsible for verifying the eligibility of prospective purchasers.

The definition of “accredited investor” has been in effect since 1982, with the only change being the exclusion of the value of the investor’s primary residence in the net worth test (adopted in early 2012). On August 26, 2020, however, the SEC opted to modernize its rules by adopting amendments to update and expand its definition of “accredited investor.” The revised rules went into effect on December 8, 2020.

WHAT IS AN ACCREDITED INVESTOR?

First, the basics: an accredited investor is a person or a business that is permitted to trade securities that have not been registered with financial authorities. By definition, these securities are regarded as carrying more risk than those that are registered because the entities that offer them have not made the disclosures required in the SEC registration process. Accredited investors achieve this special status by meeting at least one of a list of requirements including:

  • Income
  • Net worth
  • Professional experience
  • Asset size
  • Governance status

The term accredited investor is used colloquially by the SEC to describe investors considered to be financially sophisticated and therefore less in need of the legal protection provided by disclosures filed with regulators. Accredited investors include:

  • High-net-worth individuals (HNWI)
  • Brokers
  • Trusts
  • Banks
  • Insurance companies

The definition of a related term, “qualified institutional buyer,” or QIB, was also amended. A QIB is an entity that is composed of accredited investors or an entity that meets the criteria to be considered an accredited investor itself. QIBs include banks, trust funds, and pension plans.

WHAT ARE THE CRITERIA FOR AN ACCREDITED INVESTOR?

Previously, qualification was based entirely on meeting one of two conditions:

  1. A net worth of $1 million, excluding the value of a primary residence, or
  2. Annual income of at least $200,000 in each of the last two years ($300,000 of combined income for married investors)

The revised definition retains these thresholds but adds elements beyond the purely financial.

Individuals now include:

  • Licensed or certified professionals, such as holders of the following licenses:
    • Series 7 – licensed general securities representative
    • Series 65 – licensed investment adviser representative
    • Series 82 – licensed private securities offerings representative
  • Knowledgeable employees of the company that is offering the unregistered securities, including general partners, executive officers, and directors
  • Spousal equivalents, persons in relationships equivalent to marriage, whose net worth and income can now be considered in the joint qualifications

Many legal entities now qualify if they:

  1. Hold more than $5 million in assets under management, and
  2. Were not created for the specific purpose of making the investment in question

These include:

  • Limited liability companies (LLCs)
  • Family offices
  • Labor unions
  • Indian tribes
  • Governmental bodies
  • Entities organized under the laws of other countries

New additions that do not have to meet the $5 million threshold ae:

  • Investment advisers registered with the SEC and/or a state regulator
  • Exempt reporting advisers, those that serve only venture capital funds or mid-sized private funds
  • Rural business investment companies (RBICs)

LLCs and RBICs that meet the current definitional threshold of $100 million in securities can now be considered qualified institutional buyers. In addition, any entity that qualifies as an accredited investor also qualifies as a qualified institutional buyer if it clears the threshold of $100 million in securities owned and invested.

As summarized by the Chairman of the SEC, Jay Clayton:

“Today’s amendments are the product of years of effort by the Commission and its staff to consider and analyze approaches to revising the accredited investor definition. For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations, that may qualify to participate in certain private offerings.”

Want to know more about the changes to accredited investor regulations? Don’t hesitate to reach out to Valerie Barton at vbarton@trusted-counsel.com for more  information.

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