On August 26, 2020, the SEC adopted changes to its definition of “accredited investor.” The SEC Release can be found here. The new rules will become effective 60 days after their publication in the Federal Register (around the end of October 2020). These changes are definitely a move in the right direction, and they indicate that the SEC may be willing to further expand and modernize the accredited investor qualification requirements, but I don’t believe they will have a significant impact on the private securities offering process. .
The accredited investor requirements largely determine eligibility to participate in private securities offerings. The current requirements are primarily based on financial status. For most individual investors to qualify as accredited investors, they need an annual income of $200,000 (or $300,000 combined with their spouse) or a net worth (including their spouse’s net worth but excluding the value of their primary residence) of $1 million.
These quantitative requirements have been subject to criticism. They have been in effect since 1982, with the only change being the exclusion (in early 2012) of the value of the investor’s primary residence in the net worth test. Some commentators say that these requirements are too restrictive and exclude too many investors from participation in private offerings, thus stifling the capital available to smaller companies. That criticism may have become less valid over time; when the $200,000 annual income test was first implemented in 1982, less than 1% of potential investors qualified. Due to inflation and the lack of an increase in the income requirement, approximately 9% of potential investors currently qualify. . Conversely, however, this standard has been criticized by other commentators on the basis that it allows more investors to participate in risky and dangerous private investments because the qualification standards have not changed over time. This has led to some calls for indexing the income standard to inflation. The SEC did review these quantitative standards but declined to make any changes at this time.
The new accredited investor standards primarily add non-quantitative items to the list of qualification criteria. Investors who meet the following criteria may qualify as accredited investors when the new rules become effective even if they do not meet the current quantitative requirements:
- Holders of certain professional licenses which are deemed to demonstrate relevant professional knowledge. Currently this includes holders of SEC Series 7, Series 65 and Series 82 licenses, although the SEC has invited the public to propose additional certifications, designations or credentials that should be included in this definition.
- For investment in a private fund, “knowledgeable employees” of the private fund.
- Limited liability companies with at least $5 million in assets (this was largely a clarification of the existing rules, but is important given the significant growth in the use of limited liability companies).
- SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies.
- Any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
- “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.
In addition, “spousal equivalents” may now pool their financial resources with an investor for the purpose of qualifying as an accredited investor. This is significant because it shows the SEC is acknowledging a social reality rather than just a quantitative situation.
These amendments also expanded the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies, rural business investment companies and other entities if they meet the current threshold of $100 million in securities owned and invested.
What do these changes mean for private securities offerings and the available pool of accredited investors? In my view, not much. I applaud the SEC’s willingness to make these changes, but from a practical viewpoint they will probably not significantly increase the number of accredited investors or the investment capital available to private offerings. The SEC even says in its Adopting Release that it does not expect that the increase in the number of newly eligible individual accredited investors will be significant and that the amount of capital invested by such newly eligible individual investors will have a minimal effect on the private offering markets. The most positive thing that we can take from these accredited investor changes is that the SEC is actively looking at the private securities offering process and is willing to make changes.