SEC proposes to expand definitions of accredited investor and qualified institution buyer to increase private capital markets participation



December 19, 2019

Securities Law Alert

Author(s): John C. Partigan, Bohao Zhou

On December 18, 2019, the SEC proposed amendments to the definitions of “accredited investor” and “qualified institutional buyer” to increase access to investments in the private capital markets. This alert discusses what businesses and investors need to know.

On December 18, 2019, the Securities and Exchange Commission (“SEC” or the “Commission”) proposed amendments to the definition of “accredited investor” in the Commission’s rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act of 1933 to increase access to investments in the private capital markets. The proposed amendments to the accredited investor definition would add new categories of natural persons and entities to the definition, including a “catch-all” category for any entity owning in excess of $5 million in investments. Corresponding changes are also proposed to the qualified institutional buyer definition for institutions that qualify for accredited investor status when they meet the existing $100 million in securities owned and invested threshold under Rule 144A.

The accredited investor definition identifies sophisticated institutional and individual investors and is a central component of several exemptions from the registration requirements under the federal securities laws, including Rules 506(b) and 506(c) of Regulation D, which allow such sophisticated investors to participate in private capital markets. The definition also plays an important role in other federal and state securities law contexts. For example, some states use the accredited investor definition to determine whether investment advisers to certain private funds are required to be registered. FINRA rules also use the accredited investor definition to provide certain requirements and exemptions.

The proposed amendments are based on the premise that wealth – in the form of a certain level of income, net worth, or assets – should not be the sole means of establishing financial sophistication for purposes of the accredited investor definition. The amendments propose to add two new categories in the accredited investor definition for natural persons:

  • A category that would allow natural persons to qualify as accredited investors based on certain professional or educational certifications and designations, such as a Series 7, 65, or 82 license, or other credentials, including a process for the SEC to designate by order those with additional credentials as accredited investors; and
  • A category that would enable “knowledgeable employees” of a private fund to qualify as accredited investors for investments in the fund.

The amendments propose to permit natural persons to include joint income and joint net worth from spousal equivalents when determining income and net worth for purposes of qualifying as accredited investors. A “spousal equivalent” would mean a cohabitant occupying a relationship generally equivalent to that of a spouse (which the SEC previously described as including domestic partnerships, civil unions, and same-sex marriages), and assets would not need to be held jointly to be included in the calculation.

In addition, under the proposed rules, the existing income and net worth tests for individual accredited investor status, which were established in 1982, would not be updated or indexed for inflation. This is likely to substantially increase the percentage of U.S. households that would qualify as accredited investors in the future.

With respect to institutional investors, the amendments propose to add the following entity types to the current list of entities that may qualify as accredited investors:

  • Investment advisers registered under Section 203 of the Investment Advisers Act and investment advisers registered under the laws of the various states;
  • Rural business investment companies (“RBIC”), as defined in Section 384A of the Consolidated Farm and Rural Development Act;
  • Limited liability companies that have total assets in excess of $5 million and were not formed for the specific purpose of acquiring the securities offered;
  • Any entity, including Indian tribes, labor unions, government bodies and funds, and entities organized under the laws of a foreign country, owning “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered; and
  • “Family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act.

The proposed amendments to the qualified institutional buyer definition correspond to those to the accredited investor definition. Specifically, the amendments would add RBICs and limited liability companies to the entity types that are eligible for qualified institutional buyer status if they meet the $100 million in securities owned and investment threshold in the definition. Further, the proposed amendments would also add a “catch-all” category to allow an institutional investor that is of an entity type not already included in the qualified institutional buyer definition but would qualify as an accredited investor, to qualify as qualified institutional buyers when such institutional investor satisfies the $100 million threshold.

The proposal will be open to public comment for 60 days upon its publication in the Federal Register. The full text of the proposal is available here.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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