SEC Proposes Allowing Additional Individuals and Entities to Participate in Private Offerings
The Securities and Exchange Commission has recently proposed adding new categories of individuals and entities that would qualify as “accredited investors” and expanding the list of eligible entities that would qualify as “qualified institutional buyers” for purposes of purchasing securities in private offerings.
If adopted, the proposed amendments would make the following principal changes:
- Professional Certifications. The proposed rules would provide that any individual holding one or more “professional certifications or designations or credentials” from an accredited educational institution that the SEC has designated as a qualifying institution would qualify as an “accredited investor.” The proposal does not specify exactly which professional certifications and institutions would qualify, but suggests that the SEC would preliminarily deem three certifications administered by FINRA as qualifying: a licensed general securities representative (Series 7), a licensed investment adviser representative (Series 65), and a licensed private securities offerings representative (Series 82). As of December 2018, there were 691,041 registered securities representatives and 17,543 state registered investment adviser representatives – as proposed, each of these individuals would become accredited investors if not so already.
- Family Offices. The proposed rules would add family offices with at least $5 million in assets under management and their family clients to the accredited investor definition. The SEC cites estimates that currently 2,500 to 3,000 single family offices manage more than $1.2 trillion of assets.
- Spousal Equivalents. The proposed rules would expand the definition of spouse in the provision currently qualifying an individual with income of $300,000 or net worth of $1 million (in each case together with a spouse) as an accredited investor to include a spousal equivalent – defined as a cohabitant occupying a relationship generally equivalent to that of a spouse.
- Other Entities with $5 Million of Investments. The proposed rules would provide that any entity (including, for example, governmental entities, Indian tribes, and new types of entities created in the future) with investments in excess of $5 million would qualify as an accredited investor. In addition, federally or state registered investment advisors would qualify as accredited investors. The SEC estimated that there are approximately 13,400 SEC-registered investment advisers and 17,500 state-registered investment advisers.
- Private Fund Knowledgeable Employees. A “knowledgeable employee” of a private fund would qualify as an accredited investor for purposes of investing in that private fund’s offerings. Knowledgeable employees would include a fund’s executive officers, directors, trustees, general partners, advisory board members and employees who have participated in the investment activities of the private fund for at least 12 months. The SEC estimated that as of the fourth quarter of 2018 there were 32,202 private funds.
The proposed amendments would also expand the list of entities that are eligible to qualify as “qualified institutional buyers” under Rule 144A under the Securities Act of 1933 to avoid inconsistencies between the entity types that are eligible for accredited investor status and qualified institutional buyer status and to permit institutional accredited investors of an entity type not otherwise specified in Rule 144A to qualify for qualified institutional buyer status if they meet a $100 million in securities owned and invested threshold.
Lastly, the proposed rules would also expand the categories of institutional accredited investors (“IAIs”) that are permitted to be contacted under the “testing-the-waters” process now available to all issuers to gauge interest in an offering prior to registration.
The principal effect of expanding the pool of “accreditor investors” will be to allow a greater number of investors to participate in private offerings conducted pursuant to Regulation D under the Securities Act (frequently utilized by early stage and technology companies raising capital for their operations, and by private equity funds, venture capital funds and hedge funds raising capital for their funds). The SEC calculated that $1.7 trillion of securities were issued in the Regulation D market in 2018 (compared to $1.4 trillion issued in registered offerings). Similarly, expanding the pool of “qualified institutional buyers” would allow a greater number of investors to participate in private offerings structured to comply with Rule 144A under the Securities Act (frequently utilized for the issuance of high yield or convertible debt).
Significantly, the SEC did not propose to change the net worth or net income thresholds for an individual to qualify as an accredited investor (currently $200,000 or $1 million), even though these thresholds have not been adjusted for inflation since 1982. The SEC noted that while it may be argued that an income of $200,000 or a net worth of $1 million represents less wealth in 2019 than it did in 1982, the income and net worth thresholds still significantly exceed mean household income and net worth in the United States – the median household income in the US in 2018 was $61,927 and the median (average) net worth in the US was $29,410 ($196,200) in 2016. According to the SEC, substantially increasing the thresholds to reflect inflation since they were adopted would significantly reduce the number of individuals that currently qualify as accredited investors – the percentage of qualifying households would decline from approximately 13% today to approximately 4.2%.
The tables attached present the categories of investors that qualify as “accredited investors” and “qualified institutional buyers” under the current definitions and the expanded categories of investors that would qualify under those definitions if the proposed rules are adopted as currently proposed.