The U.S. Securities and Exchange Commission (SEC) has adopted amendments to the definition of an “accredited investor,” effectively expanding who is eligible to invest in certain private capital. The updated definition does not affect anyone currently qualified as an accredited investor—if you were accredited before, you should still be accredited.
Background on Accredited Investors
Participation in investment opportunities offered under exemptions that do not have the disclosure, procedural, and investor protection requirements provided by registration under the Securities Act of 1933 is limited to “accredited investors,” a term defined in Rule 501(a) and also found in Rules 215 and 144A of the Securities Act.
According to the current definition, an accredited investor can be a person or entity that meets certain income, net worth, or total assets qualifications. Broadly, an accredited investor is a person who exceeds a certain income or net worth threshold. (See the SEC’s Accredited Investors bulletin from Jan. 31, 2019, for these thresholds and other applicable rules.)
The SEC has historically maintained that the accredited investor definition is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or fend for themselves render the protections of the Securities Act’s registration process unnecessary.” The amended definition is based on the belief that wealth should not be the sole means of establishing financial sophistication. An individual’s ability to analyze potential risks and rewards, to effectively allocate investments to mitigate undue risk, to access and understand information about an issuer or an investment opportunity, and to bear the risk of the loss are factors that the SEC felt should be incorporated.
New Amended Definition
According to the SEC’s Aug. 26, 2020, press release, “The amendments update and improve the definition [of an accredited investor] to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.”
The updated definition of an accredited investor expands the existing qualifications with amendments to revise Rules 501(a), 215, and 144A of the Securities Act. In general, the SEC will allow individuals to qualify as an accredited investor based on certain professional certifications, designations, or credentials, as well as “knowledgeable employees” of a private fund. Also, the income and net worth qualifications that apply jointly to an individual and his or her spouse is expanded to include a “spousal equivalent,” which is defined as a cohabitant with a relationship generally equivalent to that of a spouse.
Additionally, certain non-natural person entities (such as limited liability companies, Indian tribes and governmental bodies, and “family offices”) may now also qualify as accredited investors if they meet certain minimum asset qualifications described in the amendments.
In summary, the expansion includes the following as new qualifications for being an accredited investor:
- Persons holding certain professional certifications, designations, or credentials
- “Knowledgeable employees” of a private fund
- Limited liability companies and certain other entities with $5 million minimum assets
- Certain qualified entities, such as Indian tribes and governmental bodies, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million
- “Family offices” with minimum $5 million in assets under management that meet certain requirements
- “Spousal equivalents” allowed to pool finances for the purpose of qualifying as accredited investors under the rules for joint finances
With these new rules, the SEC states that the updates are meant to “simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.”
The amendments with these updated definitions of an accredited investor will become effective 60 days after publication in the Federal Register. For more details, you can review the SEC’s fact sheet and the Final Rule.
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.