SEC expands definition of “accredited investor”, granting startups and growing companies easier access to capital.
The United States Securities and Exchange Commission (the “Commission”) adopted a new rule on August 26, 2020, which expands the definition of the term, “accredited investor.” The term, “accredited investor,” defines a subset of persons that are eligible to invest, under certain circumstance, in companies that have not completed the formal registration process with the Commission. The registration process is expensive and resource and time intensive, so any expansion of the exemptions from registration helps startups and growing companies gain access to needed capital.
Individuals
Until now, whether an individual was an “accredited investor” was based on such individual’s income or net worth, because the Commission believed that wealth was an adequate “proxy for financial sophistication.”[1] An individual qualifies as an accredited investor if such individual either (a) has, or together with such individual’s spouse has, a net worth in excess of $1,000,000;[2] or (b) had income “in excess of $200,000 in each of the two most recent years,” or together with such individual’s spouse had income in excess of $300,000 in each of the two most recent years, and such individual “has a reasonable expectation of reaching the same income level in the current year.”[3]
Following the issuance of the final rule, an individual also qualifies as an accredited investor if such individual either (a) holds “one or more professional certifications or designations or other credentials from an accredited educational institution that the Commission has designated as qualifying an individual for accredited investor status”; [4] or (b) is a “knowledgeable employee,” “of the private-fund issuer of the securities being offered or sold.”[5]
Professional Qualifications
Initially, the Commission has determined that an individual holding one of the “following certifications or designations administered by the Financial Industry Regulatory Authority, Inc. (FINRA)” will qualify as an accredited investor: the Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82).[6] In addition to the foregoing FINRA certifications and designations, “the Commission may designate qualifying professional certifications, designations, and other credentials by order.”
Knowledgeable Employees
The term, “knowledgeable employee” is defined in the same way that term is defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940 (the “Investment Company Act”).[7] The term, “includes, among other persons, trustees and advisory board members, or persons serving in a similar capacity,” of a fund that falls into one or more exclusions from the definition of “Investment Company” under the Investment Company Act, “or an affiliated person of [such] fund that oversees [such] fund’s investments.”[8] The term also includes “employees of [such] private fund or the affiliated person of [such] fund (other than employees performing solely clerical, secretarial, or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund for at least 12 months.”[9]
Spousal Equivalents
The final rule also clarifies that the income of an individual’s “spousal equivalent” and the net worth of such spousal equivalent can be taken into consideration when calculating such individual’s income or net worth for determining whether such individual qualifies as an accredited investor. Under the final rule, a spousal equivalent is defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse.”[10]
Entities
Entities can also qualify as accredited investors and the final rule both expanded and clarified what types of entities fall under the definition. The final rule expanded what type of entities qualify as accredited investors by adding certain “family offices” that have more than $5,000,000 in assets under management.[11] The final rule also expands the definition of accredited investor to include “family clients” of a qualifying family office “whose prospective investment in the issuer is directed by such family office.”[12]
The final rule also clarified that certain entity types not already included within the definition of accredited investor could qualify as accredited investors so long as they meet certain requirements set forth in the final rule.