White Paper: Analyzing The Potential Effect Of The SEC's Recent Changes To The "Accredited Investor" Definition

• Published date: 14 December 2020
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities
• Law Firm: Freeborn & Peters LLP
• Author: Mr Anthony J. Zeoli

The "accredited investor" definition, which has not changed significantly since its enactment almost 40 years ago, has been massively upgraded. On August 26, 2020 the Securities and Exchange Commission ("SEC") adopted final amendments to the "accredited investor" definition which fundamentally change and broaden the qualification standards and increase access to investments in the private capital markets. These amendments are game changing and include both new, non-wealth based, categories for individuals as well as several new entity categories. Corresponding changes are also made to the "qualified institutional buyer" definition in Rule 144A.

Background

The "accredited investor" definition is one of the most important definitions in all of securities law. In particular, this definition is a central component in the use of several exemptions from registration under the Securities Act of 1933 (the "Act") and state securities law; most notably, Rule 506 of Regulation D of the Act (17 CFR 230.506). Put another way, qualifying as an "accredited investor" is important because whether a person/entity qualifies will determine whether they will be permitted to invest (and in some cases how much they will be permitted to invest) in private capital market investments (i.e. investments in private companies and offerings by certain funds, not generally available to non-accredited investors).¹

The "accredited investor" qualification standards are most notably codified in Rule 501 of Regulation D of the Act (17 CFR 230.501). Simply speaking, under the current definition only individuals who have an annual income of at least $200,000 (or $300,000 of joint income) for the past two years, or who have a net worth of at least $1 million (excluding the value of their primary residence) would qualify as an "accredited investor." On the entity side, only entities which are entirely owned by individuals who each meet the foregoing test, trusts with assets over $5 million, and a limited number of other entities (e.g. banks, insurance companies, certain benefit plans, etc.) would qualify as an "accredited investor." The current definition has been the topic of much debate, particularly because they are entirely based on the premise that wealth (i.e. a certain level of income, net worth, or assets) is the only way to determine financial sophistication.

For some time the SEC has been considering ways to, in its own words, "simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation." In particular, since June of 2019, the SEC has released a series of proposals/reports discussing potential amendments to the existing "accredited investor" definition and opening the same to public comment. Their efforts culminated on August 26, 2020 with the adoption and release of its final rule which significantly amends Rule 501.²

In the final release, SEC Chairman Jay Clayton is quoted as saying:

"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."

Amendments

Generally speaking, the amendments significantly broaden the current "accredited investor" definition by adding several new categories of qualifying natural persons and entities. These newer categories represent persons/entities the SEC believes do not need the additional protections afforded by registration under the Act because they have enough...