The changes would allow more individuals and institutions to invest in private offerings of unregistered securities.
By Alexander F. Cohen, Paul M. Dudek, Joel Trotter, Dana G. Fleischman, Stephen P. Wink
On August 26, 2020, the US Securities and Exchange Commission (SEC) expanded the definitions of accredited investor (AI) and qualified institutional buyer (QIB). Notably, while the SEC added to the categories of individuals and entities that qualify as AIs and QIBs, it did not change any of the existing financial thresholds. It also made a conforming change to testing the waters under Rule 163B. Highlights include:
Expansion of the AI Definition
- New Catch-All Category. Any entity that owns “investments” within the meaning of Investment Company Act Rule 2a51-1(b) greater than US$5 million, and that is not formed for the specific purpose of acquiring the securities being offered, will be an AI (new Rule 501(a)(9)). The SEC declined to provide a laundry list of qualifying entities, although the Adopting Release specifically mentions Indian tribes, governmental bodies, and foreign entities. Sovereign wealth funds and various types of trusts are also likely to be covered.
- Limited Liability Companies (LLCs). Codifying a long-standing SEC Staff interpretive position, LLCs with total assets in excess of US$5 million have been added to the list of entities qualifying as an AI (amended Rule 501(a)(3)).
- Credential Holders Designated by the SEC; Series 7, Series 82, and Series 65 Licenses. The AI definition will include any natural person holding in good standing a professional certification, designation, or credential that the SEC has designated by order as qualifying for AI status (new Rule 501(a)(10)). Qualifying criteria include whether the certification arises out of an examination demonstrating securities and investing sophistication. The SEC issued an initial order to cover the General Securities Representative license (Series 7), the Private Securities Offerings Representative license (Series 82), and the Investment Adviser Representative license (Series 65).
- “Knowledgeable Employees.” Knowledgeable employees within the meaning of Investment Company Act Rule 3c-5(a)(4) will be AIs (new Rule 501(a)(11)). This category includes trustees, advisory board members, and employees who participate in the investment activities of a private fund under Investment Company Act Section 3(c)(1) or Section 3(c)(7).
- SEC-Registered Investment Advisers (IAs); State-Registered IAs; Exempt Reporting IAs. IAs registered with the SEC under Section 203 of the Advisers Act will be AIs, as will state-registered IAs and IAs qualifying as an “exempt reporting adviser” under Advisers Act Section 203(m) (advisers to private funds) or Section 203(l) (advisers to venture funds) (amended Rule 501(a)(1)).
- Family Offices and Family Clients. Certain family offices with greater than US$5 million in assets under management and their family clients are now AIs (new Rules 501(a)(12) and (13)).
Expansion of the QIB Definition
- Any institutional AI under revised Rule 501(a) that is not already covered in the QIB definition can now qualify as a QIB if it meets Rule 144A’s US$100 million unaffiliated investments test (new Rule 144A(a)(1)(i)(J)). The inclusion of a catch-all category to the QIB definition will benefit large investment entities that did not fit neatly into the prior specific categories.
Conforming Changes to Testing the Waters
- The SEC is making conforming changes to Rule 163B (testing the waters) to cover the additional categories of new institutional AIs. In particular, exempt water testing can now be done with entities such as governmental bodies under Rule 501(a)(9), as well as certain family offices and certain institutional family clients under Rules 501(a)(12) and (13) (amended Rule 163B(c)(2)).
The changes will take effect 60 days after publication in the Federal Register, an unpredictable process that can take several weeks.
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