SEC Expands Accredited Investor Definition

By Rose B. Sorensen and Carmen B. Gilbert

On August 26, 2020, the U.S. Securities and Exchange Commission (SEC) adopted changes to expand its longstanding definition of “accredited investor.” The changes are the culmination of efforts by the SEC that began with its December 2015 staff report on the history of the accredited investor definition, followed by its June 2019 concept release and December 2019 proposed rules. The adopted amendments largely track the proposed rules and will become effective around the end of October 2020, 60 days after publication in the Federal Register. The existing definition of an accredited investor in Rule 215 and Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as amended, has been in place without any significant update since 1982 and the SEC’s changes reflect a shift towards the belief that sophistication can make someone an accredited investor without regard to their financial resources.

This shift is significant because investments in certain kinds of private securities offerings, such as private equity funds, crowdfunding ventures or private placement programs, are restricted to accredited investors who are deemed to be able to handle these complex and potentially risky investment transactions that are less regulated than publicly traded assets. In its announcement, the SEC acknowledged that the existing rules allowed high-income individuals to invest in private markets while seemingly ignoring “institutional and individual investors that have the knowledge and expertise to participate in those markets.” The changes seek to strike a balance between expanding the definition to include investors with reliable alternative indicators of financial sophistication and maintaining the safeguards necessary for investor protection and public confidence.

The changes also create new categories of individuals and entities that qualify as accredited investors irrespective of their wealth, on the basis that they have demonstrated the requisite ability to assess an investment opportunity. When the changes become effective, the following will be considered accredited investors:

• Individual investors with Series 7, Series 65 and Series 82 licenses in good standing, regardless of their net worth or annual income;
• “Knowledgeable employees” of private investment funds, regardless of their net worth or annual income, for investments in the fund that employs them;
• SEC or state-registered investment advisers and exempt reporting advisers;
• Rural business investment companies (RBICs);
• Limited liability companies with $5 million in assets and not formed for the specific purpose of investing in the securities offered;
• Any entity, including Indian tribes, labor unions, governmental bodies and funds, and entities organized under the laws of foreign countries, owning “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act) in excess of $5 million and not formed for the specific purpose of investing in the securities offered; and
• Family offices (as defined under the Advisers Act) with at least $5 million in assets under management, not formed for the specific purpose of investing in the securities offered, and whose “prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.” Additionally, “family clients” (as defined under the Advisers Act) of a family office that meets the aforementioned requirements, whose prospective investment is directed by such family office.

Additionally, changes adopted by the SEC will allow “spousal equivalents” to pool their finances for the purpose of qualifying as accredited investors.

These changes to the accredited investor definition will expand the number of individual investors and entities that qualify to make certain private investments in line with the SEC’s goal to “promote capital formation and expand investment opportunities while maintaining and enhancing appropriate investor protections.” Rather than relying on wealth to determine whether an individual is adequately protected in making investment decisions, these new rules allow for sophistication to be taken into account.