SEC Expands Population Eligible to Participate in Certain Private Offerings

Jenna E. Levine and Raaj S. Narayan are partners and Ram Sachs is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum.

The SEC yesterday [August 26, 2020] voted 3-2 to adopt amendments expanding the definition of “accredited investor,” with related expansions to the entity types that may qualify as “qualified institutional buyers” under Rule 144A.  These changes, which will become effective sixty days after publication in the Federal Register, are part of the SEC’s broad ongoing project to harmonize the exempt offering framework in recognition of the growing importance of the private market and will enable additional individuals deemed to have sufficient knowledge or expertise to participate in private offerings currently open to wealthy individuals without meeting the existing wealth-based criteria.  SEC Chairman Jay Clayton explained that these changes are intended to advance the policy goal of “‘identify[ing] investors that have sufficient financial sophistication to participate in investment opportunities’ in the private capital markets.”

Under the current asset and income-based approach, individuals must generally have a net worth of at least $1 million (excluding the value of their primary residence), or an annual income of at least $200,000 for the last two years ($300,000 for married couples), with a reasonable expectation of that level for the current year.  The definition also includes certain entities with assets over $5 million.  The new rules expand the scope to include individuals with certain professional certificates or credentials as determined by the SEC, which the adopting release indicates the SEC believes provide a reliable indication of the ability to appropriately assess an investment opportunity and make informed decisions on asset allocation and risk tolerance.  The initial qualifying certifications are FINRA Series 7, 65, and 82 licenses.  It is specifically contemplated that the SEC may expand the list in the future after observing the impact of the initial rule change.

“Knowledgeable employees” of a private fund (defined under Rule 3c-5(a)(4) of the Investment Company Act), generally including officers, directors, partners, and employees regularly and actively participating in the investment activities of a fund for at least twelve months in a non-administrative capacity, will also be deemed to be accredited investors for purposes of investments in the specific fund with which they are affiliated.

The amendments also expand or codify the list of entities that qualify as accredited investors (including family offices and limited liability companies) if they meet the financial thresholds, add a catch-all “investments-owned test” that captures entities of any type with investments in excess of $5 million that were not formed for the specific purpose of acquiring the securities being offered, and make related changes to the types of entities eligible as qualified institutional buyers under Rule 144A.

While many qualifying individuals or entities under the new rules likely already met the existing income or asset thresholds, issuers planning a private offering may benefit from increased access to newly eligible investors or easier verification of an accredited investor’s qualifications.  An increased number of investors will now have access to investments in sectors that have increasingly shunned the public market.  It will remain important for issuers conducting private offerings to implement and adhere to appropriate procedures to screen offering participants under all then-applicable criteria.

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