SEC adopts an Expanded Definition of “Accredited Investor” - 01 September 2020

The SEC adopted a regulatory amendment designed to expand who may be an accredited investor.

On August 26, 2020, the revision to the accredited investor definition was adopted seriatim by a divided Commission in a 3-2 vote. (Amending the "Accredited Investor" Definition, Release No. 33-10824, August 26, 2020).

Accredited investor definition.

The centerpiece of the revised definition of "accredited investor" is its expansion of the types of persons who can be accredited investors. Historically, an accredited investor was a particular type of financial institution or an individual of specified wealth. Those definitions remain largely untouched, but the adopting release adds language to include other persons within the definition of accredited investor. As a result, the definition will now include:

• Persons who hold a professional credential that the Commission has designated as indicative of accredited investor status. The SEC will publish such current designations on its website and can by order adopt more designations following notice and public comment. The Commission has already issued an order designating the following: (1) General Securities Representative license (Series 7), (2) the Private Securities Offerings Representative license (Series 82), and (3) the Investment Adviser Representative license (Series 65).
• Certain knowledgeable employees; and
• Family offices and family clients; a family office must have assets under management of more than $5 million, not be formed for the specific purpose of acquiring the securities offered, and the investment must be directed by a person with the requisite experience to evaluate the merits and risks of the investment.

Commissioners’ Reactions.

Chairman Clayton lauded the release as a long-overdue revamp of the accredited investor definition. "Individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks of participating in unregistered offerings, are denied the opportunity to invest in our private markets. For example, using only a binary test for wealth disadvantages otherwise financially sophisticated Americans living in lower income/cost-of-living areas." He also deflected criticism that the expanded definition will increase private financings at the expense of initial public offerings, suggesting that there will be little impact on aggregate capital flows in public and private markets and insisting that the SEC remains committed to promoting U.S. public capital markets.

Commissioner Peirce said the amended definition was a "cautious expansion" of who may be an accredited investor, but she also questioned if the expansion goes far enough, citing the connections between freedom, responsibility, and liberty interests: "Why shouldn’t mom and pop retail investors be allowed to invest in private offerings? Why should I, as a regulator, decide what other Americans do with their money?"

Likewise, Commissioner Roisman noted that "wealth is a crude measure" by which to judge a person’s investment abilities. He also said future changes to the definition of accredited investor were possible and that a future Commission should ask if the monetary thresholds in the definition limit opportunities for women and minorities. With respect to the Commission order designating three professional credentials, Commissioner Roisman noted that holders of these credentials likely would also meet the wealth tests in the definition of accredited investor.

Commissioners Lee and Crenshaw jointly dissented from the accredited investor release. The commissioners objected to the lack of economic analysis justifying the revisions, the absence of an inflation adjustment to the net worth and income tests, and the general expansion of private capital markets and the associated risks, including risks to seniors. The first footnote to the joint dissent emphasized the rationale behind these critiques: "Private offerings lack the traditional investor protections that attach to registration, most importantly transparency and liquidity. Thus, the principal means of protecting investors in private markets is to work to ensure that those offering unregistered securities can only sell to investors who can assess and bear the heightened risks in private markets. Some argue that such an effort is paternalistic and that all investors should be free to risk their livelihoods as they see fit. But that evinces a disregard for the very reason the SEC was created and the fundamental differences between the public and private markets. The SEC’s core mission is to protect investors and we should not substitute a policy of ‘caveat emptor’ for meaningfully carrying out that mission."

Other Considerations – “spousal equivalent”; Regulation Best Interest; "qualified institutional buyer”

The accredited investor release also made some textual adjustments to the net worth and income tests for accredited investor status. For one, both the net worth and income provisions add language to make them applicable to a person’s spouse or "spousal equivalent." The term "spousal equivalent" is defined to mean "a cohabitant occupying a relationship generally equivalent to that of a spouse." That definition is consistent with other uses of the term in federal securities regulations; the final release declined to adopt a different or more limited definition. Second, the release added a note to the net worth provision to clarify that net worth can be aggregate net worth. Moreover, to satisfy the joint net worth test, an asset need not be held jointly, and securities need not have been jointly purchased. However, the release did not alter the financial thresholds applicable to the net worth and income tests.

A question could arise whether there is any interaction between the expanded accredited investor definition and Regulation Best Interest. Regulation BI imposes enhanced requirements on broker-dealers who advise retail investors, including specific obligations regarding disclosure, care, conflicts of interest, and compliance. To be sure, there are few direct connections between the two regulations because accredited investors typically are persons for whom formal disclosures are not needed because they can fend for themselves due to their financial sophistication or wealth. However, the SEC’s Division of Trading and Markets has issued an FAQ that explains how Regulation BI may apply in some limited instances:

"Q: Does Regulation Best Interest apply to limited purpose broker-dealers, for example, broker-dealers that make recommendations of private offerings to accredited investors?"

"A: Yes, if that accredited investor is a ‘retail customer’ as defined in the rule. The definition of "retail customer" does not exclude high-net worth natural persons and natural persons that are accredited investors. Whether a broker-dealer engages in limited activity does not dictate whether or not Regulation Best Interest applies. Regulation Best Interest applies to broker-dealers that make recommendations of any securities transaction or investment strategy involving securities to retail customers. (Posted February 11, 2020)."

Lastly, the accredited investor release makes changes to the definition of "qualified institutional buyer" under Securities Act Rule 144A. Specifically, the release clarifies the eligibility of certain small business investment trusts, Internal Revenue Code Section 501(c)(3) entities’ (adds limited liability companies), and institutional accredited investors (may be formed for the purpose of acquiring offered securities).

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