The SEC adopted, by a 3-2 vote along party lines, amendments to the definitions of "accredited investor" in Rule 501(a) of Regulation D and "qualified institutional buyer" in Rule 144A to increase accessibility to private capital markets (see previous coverage). The amendments will become effective 60 days after publication in the Federal Register.
A summary of the amendments is below with our comments on the amendments. A fuller Cadwalader memorandum detailing the amendments can be found here.
The amendments to the "accredited investor" definition will:
- add new categories allowing natural persons to qualify as accredited investors based on certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution;
- add a new category for investments in a private fund based on the person's status as a "knowledgeable employee" of the fund;
- expand the current list of entities that may qualify as accredited investors to include limited liability companies with at least $5 million in assets, registered investment advisers, exempt reporting advisers and rural business investment companies ("RBICs");
- introduce a new category for any entity, including a tribal government, owning investments in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
- add "family offices" with at least $5 million in assets under management and their "family clients" (as each term is defined under the Advisers Act); and
- add the term "spousal equivalent" to the accredited investor definition by allowing spousal equivalents to pool their finances for the purpose of qualifying as accredited investors.
Additionally, the "qualified institutional buyer" definition will be amended to:
- expand the types of entities eligible for qualified institutional buyer status to include certain limited liability companies and RBICs, if they meet the $100 million in securities owned and investment threshold in the definition; and
- add a "catch-all" category permitting certain institutional accredited investors to be qualified institutional buyers after satisfying the $100 million threshold.
In a joint statement, SEC Commissioners Allison Herren Lee and Caroline Crenshaw criticized the amendments for purporting to modernize the definition of "accredited investor" while failing to update the 38-year old wealth thresholds and to index the wealth thresholds to inflation. Further, Ms. Lee and Ms. Crenshaw cautioned that the amendments expand the private market without sufficient data on the impact of the expansion or analysis of the risks the amendments pose for investors, particularly seniors.
SEC Commissioner Elad Roisman praised the amendments for introducing a "demonstrable knowledge-based component" that will provide opportunities for people to qualify as accredited investors without having to rely on wealth. Mr. Roisman expressed support for the further review of monetary thresholds in the definition of "accredited investor." SEC Commissioner Hester Peirce also expressed support for the amendments, stating that they are rooted in the understanding that wealth is not always the best proxy for investor sophistication.
SEC Chair Jay Clayton addressed the criticism that the amendments will pose greater risks to investors, highlighting that the expansion of the definition of "accredited investor" is limited and likely to be most impactful in small, local business financing. Additionally, Mr. Clayton responded to the argument that the wealth thresholds should be modified, explaining that the argument itself demonstrates why it is unsatisfactory to rely on wealth as the sole criterion for participation in the private market.
The amendments to the "accredited investor" definition are consistent with the agenda of the SEC under Commissioner Clayton to promote capital formation and expand investment opportunities in the U.S. financial markets. The amendments, which impact Reg D issuers (e.g., private funds) and their investors, add new categories to the accredited investor definition and do not limit any existing categories. Despite commentary from the industry and dissenting commissioners, the SEC did not raise any of the financial thresholds in the current definition (i.e., for natural persons, $1 million net worth or $200,000 income for individuals/ $300,000 income for couples, or for entities, $5 million in assets), in effect generally in form since 1982. Sophistication levels are the focus rather than financial thresholds.
As a practical matter, private fund managers should begin updating their fund documentation, including subscription agreements, to allow for the new categories of accredited investors. The effective date is 60 days after publication in the Federal Register.
The divided SEC vote reflects the sharp philosophical divide between the Commissioners. The three Republican Commissioners, who supported the rule changes, were primarily motivated by the belief that expanding the categories of persons who are permitted to invest in private placements would facilitate capital raising by small businesses, particularly by very small businesses. Conversely, the two Democratic Commissioners, who dissented, were primarily concerned that failing to raise wealth/income thresholds where they are used to determine eligiblity, would, through the powers of inflation, gradually allow ever-less sophisticated (or at least ever-less truly wealthy) individuals to make investments that they would be unable to evaluate.
- Cadwalader Clients & Friends Memorandum: SEC Adopts Rule Amendments Designed to Expand Access to Private Investment Opportunities
- SEC Press Release: SEC Modernizes the Accredited Investor Definition
- SEC Final Rule: Amending the "Accredited Investor" Definition
- SEC Joint Statement, Allison Herren Lee and Caroline Crenshaw: The Failure to Modernize the Accredited Investor Definition
- SEC Statement, Elad L. Roisman: Statement on Amending the "Accredited Investor" Definition
- SEC Statement, Hester M. Peirce: Statement on Amending the "Accredited Investor" Definition
- SEC Statement, Jay Clayton: Statement on Modernization of the Accredited Investor Definition
- NASAA Statement: The SEC's Amendment of Accredited Investor Definition
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.