SEC Proposes to Update the Definition of “Accredited Investor”
The SEC has proposed amendments to the definition of “accredited investor” to add new categories of qualifying natural persons and entities and to make certain other modifications to the existing definition. Specifically, the proposed amendments:
- would add new categories of natural persons that may qualify as accredited investors based on certain professional certifications or designations or other credentials or their status as a private fund’s “knowledgeable employee;”
- expand the list of entities that may qualify as accredited investors and allow entities meeting an investments test to qualify;
- add family offices with at least $5 million in assets under management and their family clients; and
- add the term “spousal equivalent” to the definition.
Professional Certifications and Designations and Other Credentials
The SEC is proposing to amend the rule to include natural persons holding one or more professional certifications, designations or other credentials issued by an accredited educational institution that the SEC designates from time to time as meeting specified criteria. An investor would need to maintain these certifications, designations, or credentials in good standing in order to qualify for accredited investor status.
The SEC’s designation of certifications, designations, or credentials would be based upon its consideration of all the facts pertaining to a particular certification, designation, or credential. The proposed amendment would provide a non-exclusive list of attributes that the SEC would consider in determining which professional certifications, designations or other credentials qualify for accredited investor status.
The SEC preliminarily expects that the following certifications or designations would be included in an initial SEC order accompanying the final rule, if adopted:
- Licensed General Securities Representative (Series 7);
- Licensed Investment Adviser Representative (Series 65); and
- Licensed Private Securities Offerings Representative (Series 82).
Knowledgeable Employees of Private Funds
Pursuant to Rule 3c-5 of the Investment Company Act, “knowledgeable employees” of a private fund (such as hedge funds, private equity funds and venture capital funds) may acquire securities issued by the fund without being counted for purposes of investor limits. This provision permits individuals who participate in a fund’s management to invest in the fund as a benefit of employment.
The proposed new category of accredited investor would be the same in scope as the definition of “knowledgeable employee” in Rule 3c-5(a)(4). It would include, among other persons, trustees and advisory board members, or persons serving in a similar capacity, of specified funds or an affiliated person of the fund that oversees the fund’s investments, as well as employees of the private fund or the affiliated person of the fund (other than employees performing solely clerical, secretarial, or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund for at least 12 months.
Proposed Note to Rule 501(a)(5)
The SEC is proposing to add a note to Rule 501 to clarify that the calculation of “joint net worth” for purposes of Rule 501(a)(5) can be the aggregate net worth of an investor and his or her spouse (or spousal equivalent if “spousal equivalent” is included in Rule 501(a)(5), as proposed), and that the securities being purchased by an investor relying on the joint net worth test of Rule 501(a)(5) need not be purchased jointly.
Registered Investment Advisers
The SEC proposes to include investment advisers registered under Section 203 of the Investment Advisers Act and investment advisers registered under the laws of any state in the definition of accredited investor.
Limited Liability Companies
Given the widespread adoption of the limited liability company as a corporate form, the SEC proposes to include limited liability companies in Rule 501(a)(3). The proposed amendment would codify a longstanding staff position that limited liability companies that satisfy the other requirements of the definition are eligible to qualify as accredited investors under Rule 501(a)(3).
The SEC also notes the term “executive officer” is defined in Rule 501(f) as “the president, any vice president in charge of a principal business unit, division or function, as well as any other officer who performs a policy making function, or any other person who performs similar policy making functions for the issuer.” The SEC believes that a manager of a limited liability company performs a policy making function for the issuer equivalent to that of an executive officer of a corporation under Rule 501(f), and therefore the SEC does not believe it is necessary to amend Rule 501(a)(4) or Rule 501(f) to specifically include managers of limited liability companies.
The SEC is proposing to add a new category in the accredited investor definition for any entity owning investments in excess of $5 million that is not formed for the specific purpose of acquiring the securities being offered. As shown by the emergence of limited liability companies, it is possible that an entirely new corporate form could gain acceptance but not come within the scope of Rule 501(a). Proposed Rule 501(a)(9) is intended to capture all existing entity forms not already included within Rule 501(a), such as Indian tribes and governmental bodies, as well as those entity types that may be created in the future.
To assist both issuers and investors, the SEC proposes to incorporate the definition of investments from Rule 2a51-1(b) under the Investment Company Act, which includes, among other things: securities; real estate, commodity interests, physical commodities, and non-security financial contracts held for investment purposes; and cash and cash equivalents. By using an existing definition, the SEC hopes to alleviate confusion and facilitate compliance.
Proposed Note to Rule 501(a)(8)
Under Rule 501(a)(8), an entity qualifies as an accredited investor if all of the equity owners of that entity are accredited investors. Because in some instances, an equity owner of an entity is another entity, not a natural person, the SEC is proposing to add a note to Rule 501(a)(8) that would clarify that, in determining accredited investor status under Rule 501(a)(8), one may look through various forms of equity ownership to natural persons.
Certain Family Offices and Family Clients
The SEC proposes to amend the definition of accredited investor to include any “family office” with at least $5 million in assets under management and its “family clients,” each as defined in the family office rule set forth in Investment Advisers Act Rule 202(a)(11)(G)-1. The SEC believes requiring the family office to have a minimum amount of assets under management would ensure the family office has sufficient assets to sustain the risk of loss. In addition, the proposed definition would apply only to a family office whose purchases are directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment. In order to avoid improper reliance on the amended rule, the SEC also proposes that the family office not be formed for the specific purpose of acquiring the securities offered and that a family client must be a family client of a family office that meets these requirements. The SEC expects that all or most current family offices would be accredited investors under the proposed amendments to the definition.
Permit Spousal Equivalents to Pool Finances for the Purposes of Qualifying as Accredited Investors
The SEC proposes to allow natural persons to include joint income from spousal equivalents when calculating joint income under Rule 501(a)(6), and to include spousal equivalents when determining net worth under Rule 501(a)(5). The proposed amendments would define spousal equivalent as a cohabitant occupying a relationship generally equivalent to that of a spouse.