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SEC Amends “Accredited Investor” and “Qualified Institutional Buyer” Definitions under the Securities Act九月 8, 2020
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On August 26, 2020, the Securities and Exchange Commission adopted amendments to “modernize” the definitions of (i) “accredited investor” in Rule 501 of Regulation D under the Securities Act of 1933 and (ii) “qualified institutional buyer” in Rule 144A under the Securities Act, two of the principal definitions relevant to issuers seeking to raise capital in the private market. In adopting the amendments, SEC Chairman Jay Clayton explained that “[f]or 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.” The amendments become effective 60 days after publication in the federal register.
The adopting release is available here.
The amendments allow investors who are natural persons to qualify as accredited investors based on qualitative expertise and measures of professional knowledge, experience, or certifications in addition to the existing quantitative tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, and allow any entity that meets an investments-owned test to qualify. Notably, the amendments do not increase the 38-year-old monetary thresholds in Rule 501 or the $100 million threshold in Rule 144A, or otherwise index any relevant monetary thresholds to inflation.
I. Regulation D under the Securities Act
Regulation D under the Securities Act provides a non-exclusive safe-harbor exemption under Section 4(a)(2) of the Securities Act from the Section 5 registration requirement of the Securities Act for offers and sales of securities by issuers of the securities under certain conditions. In relevant part, Rule 506 of Regulation D provides an exemption for offers and sales of an unlimited value of securities to an unlimited number of accredited investors (and a limited number of non-accredited investors, as long as certain informational conditions are met). The amendments (i) add a new category to the definition of accredited investor that is based on possession of certain professional certifications, designations, or other credentials that demonstrate a background and understanding in the areas of securities and investing; (ii) add a new category for “knowledgeable employees” of a private investment fund to make investments in that fund; and (iii) add additional specific entities to the definition, including investment advisers registered under the Investment Advisers Act of 1940, limited liability companies, rural business investment companies (RBICs), and a “catch-all” category for entities not formed for the specific purpose of acquiring the securities that are offered and sold. Because the specific qualifying credentials are established by an SEC order, the amendments provide the SEC flexibility to evaluate and adjust the relevant professional certifications, designations, and credentials on a going-forward basis.
Below is a summary of the amendments to the accredited investor definition in Rule 501(a):
- add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations, or other credentials issued by an accredited educational institution that the SEC may designate from time to time by order. In conjunction with the adoption of the amendments, the SEC designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the SEC with flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the SEC’s consideration additional certifications, designations, or credentials that satisfy the attributes set out in the new rule;
- include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund. This will generally include directors and senior officers of the fund, the manager, and certain other employees who, in connection with their regular duties, have participated in the investment activities of the fund’s manager for at least 12 months;
- clarify that limited liability companies with $5 million in assets may be considered accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and RBICs to the list of entities that may qualify;
- add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that owns “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, 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 Investment Advisers Act; and
- add the term “spousal equivalent” to the definition of accredited investor, so that spousal equivalents may pool their finances to qualify as accredited investors.
The amendments also replace the existing accredited investor definition in Rule 215 with a cross reference to the definition in Rule 501(a) and make conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.
II. Rule 144A under the Securities Act
Rule 144A under the Securities Act provides a non-exclusive safe-harbor exemption under Section 4(a)(1) of the Securities Act from the Section 5 registration requirement of the Securities Act for resales of certain restricted securities to “qualified institutional buyers.” In most transactions effected pursuant to Rule 144A, an issuer of securities will offer and sell securities to initial purchaser broker-dealers in a transaction exempt from Securities Act registration pursuant to Section 4(a)(2) of the Securities Act. Immediately following that offer and sale, the initial purchasers resell the securities to qualified institutional buyer investors in a transaction exempt from registration pursuant to Rule 144A. The amendments expand the definition of “qualified institutional buyer” by conforming the definition to the entity amendments to Rule 501 (including adding RBICs and limited liability companies to the list of entities covered by Rule 144A), while maintaining the existing requirement that the institution must own and invest on a discretionary basis at least $100 million in securities of non-affiliates. The amendments also add a catch-all category to permit any institutional accredited investor not otherwise already captured by the rule’s definition to automatically qualify as a “qualified institutional buyer” if the investor satisfies the $100 million threshold in securities owned and invested.
This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. John-Paul Motley, an O’Melveny partner licensed to practice law in California, Shelly Heyduk, an O’Melveny partner licensed to practice law in California, Robert Plesnarski, an O’Melveny partner licensed to practice law in the District of Columbia, and James Harrigan, an O'Melveny counsel licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.
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