SEC Proposes Changes to Accredited Investor Definition

The amendments include individuals holding certain specified professional certifications, designations or other credentials in new Rule 501(a)(10). Natural persons holding the following professional licenses include: Series 7 (licensed general securities representative), Series 65 (licensed investment adviser representative) and Series 82 (licensed private securities offerings representative). The rationale is that individuals holding these certifications by virtue of passing the certification examinations have the required knowledge of the securities laws that allows them to make informed investment decisions without the need for additional protections under the securities laws.

Natural persons who are knowledgeable employees

The amendments add in new Rule 501(a)(12) "knowledgeable employees" of a private fund as a new category of natural persons qualifying as accredited investors in relation to that fund. The rationale is that by virtue of their active involvement in the activities of a fund, the employees are sufficiently sophisticated financially to be able to make informed investment decisions. Employees of a private fund who as part of their regular duties have participated in the fund's investment activities for at least 12 months fall within the amended definition. Note that knowledgeable employees of a private fund are deemed accredited investors only with respect to investments in that private fund.

The inclusion of knowledgeable employees in the definition of "accredited investor" allows these employees to invest in the private fund without the fund itself losing accredited investor status when the funds have assets of $5 million or less. Under Rule 501(a)(8), private funds with assets of $5 million or less may qualify as accredited investors if all of the fund's equity owners are accredited investors. Unless they qualify as accredited investors, these small private funds could otherwise be excluded from participating in some offerings under Rule 506 that are limited to accredited investors.

Amending the accredited investor definition in this manner would allow knowledgeable employees to invest in these small private funds as accredited investors, while permitting the funds to remain eligible to qualify as accredited investors under Rule 501(a)(8). This new category is similar to the existing category for directors, executive officers, or general partners of the issuer (or directors, executive officers, or general partners of a general partner of the issuer) in Rule 501(a)(4).

Registered investment advisers

Investment advisers registered under §203 of the Investment Advisers Act of 1940 and state registered investment advisers to Rule 501(a)(1) are added as accredited investors.

Limited liability companies

The amendments add limited liability companies to Rule 501(a)(3) as long as they meet the other requirements of the definition: 1) having total assets in excess of $5 million and 2) are not formed for the specific purpose of acquiring the securities being offered.

Entities that meet an investments-owned test

The amendments add a category in new Rule 501(a)(9) that covers entities that: 1) own investments in excess of $5 million; 2) are not formed for the specific purpose of acquiring the securities being offered; and 3) otherwise are not covered by other subsections of Rule 501(a). The new category includes entities such as Indian tribes and government bodies as well as other entity types that may be formed in the future.

Certain family offices and family clients

The amendments add family offices with at least $5 million in assets under management in new Rule 501(a)(12), provided that such family offices are not formed for the specific purpose of acquiring the securities being offered and that the purchase of the securities is directed by a person who has knowledge and experience in financial matters. The new Rule 501(a)(13) covers family clients (as defined in the Investment Advisers Act) of a family office meeting the requirements of new Rule 501(a)(12).

Spousal equivalents

The amendments revise Rules 501(a)(5) and 501(a)(6) to permit individuals to include joint income from spousal equivalents (not just joint income from a spouse, as is currently the case) when calculating the joint income thresholds. Under Rule 501(a)(6), an individual is considered an accredited investor if together with a spouse he/she exceeds the $300,000 joint income threshold. Under Rule 501(a)(5), the qualifying threshold for an individual is $1 million joint net worth.

Spousal equivalent is defined as "a cohabitant occupying a relationship generally equivalent to that of a spouse." Further, the Amendments clarify that for purposes of the calculation of joint net worth, net worth can be aggregated between the investor and his/her spouse (or spousal equivalent if the term is adopted) and that the securities purchased based on the joint net worth test may be purchased by the investor individually and do not need to be purchased jointly with the spouse (or the spousal equivalent).

Conclusion

The amendments do not propose any changes to the financial thresholds contained in the definition of accredited investor. The relevant thresholds under the definition are $5 million for total assets, $1 million for individual or joint net worth (excluding primary residence), and $200,000 for individual income or $300,000 for joint income. These thresholds have not been adjusted for inflation since 1982.

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Peter M. Fass is a partner at Proskauer Rose.