The Securities and Exchange Commission today adopted amendments to the “accredited investor” definition, one of the principal tests for determining who is eligible to participate in our private capital markets. Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to invest in our multifaceted and vast private markets. The amendments update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets.
“Today’s amendments are the product of years of effort by the Commission and its staff to consider and analyze approaches to revising the accredited investor definition,” said Chairman Jay Clayton. “For the first time, individuals will be permitted to participate in our private capital markets not only based on their income or net worth, but also based on established, clear measures of financial sophistication. I am also pleased that we have expanded and updated the list of entities, including tribal governments and other organizations, that may qualify to participate in certain private offerings.”
The amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.
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FACT SHEET
Updating the Accredited Investor Definitions
Aug. 26, 2020
The Securities and Exchange Commission adopted amendments to update and improve the definition of “accredited investor” in the Commission’s rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act of 1933. The amendments to the accredited investor definition add new categories of qualifying natural persons and entities and make certain other modifications to the existing definition. The amendments to the qualified institutional buyer definition similarly expand the list of eligible entities under that definition.
Background
These amendments are part of the Commission’s ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.
In June 2019, the Commission requested public comment on its Concept Release on Harmonization of Securities Offering Exemptions. In the Concept Release, the Commission requested comments on possible approaches to amending the accredited investor definition, which is a central component of several exemptions from registration, including Rules 506(b) and 506(c) of Regulation D, and plays an important role in other federal and state securities law contexts. The Concept Release was preceded by a Commission staff report issued in December 2015 on the accredited investor definition, which examined the background and history of the definition and considered comments and recommendations on amending the definition.
After taking into account the views expressed by members of the public and recommendations over the years from various Commission advisory committees and the annual SEC Government-Business Forum on Small Business Capital Formation, the Commission proposed in December 2019 to amend the accredited investor definition. In March 2020, the Commission continued the harmonization effort by proposing amendments to the exempt offering framework.
Highlights
The amendments revise Rule 501(a), Rule 215, and Rule 144A of the Securities Act.
The amendments to the accredited investor definition in Rule 501(a):
- add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
- include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered;
- add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
- add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.
The amendment to Rule 215 replaces the existing definition with a cross reference to the definition in Rule 501(a).
The amendments expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition. The amendments also add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
The Commission also adopted conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.
What’s Next?
The amendments and order become effective 60 days after publication in the Federal Register.
Statement On Modernization Of Accredited Investor Definition, SEC Chairman Jay Clayton
Today, the Commission adopted final rules to modernize and add much needed flexibility to the definition of “accredited investor” by adding new categories of qualifying individuals and entities that have demonstrated financial sophistication such that they should not be excluded from the very large, multifaceted and important private capital markets. The private capital markets are important to investors and issuers of various types, as well as our economy more generally. The accredited investor definition is the principal test for investor participation in significant segments of our private capital markets. It also plays an important role in other state and federal securities law contexts.
The test for individuals to qualify as accredited investors has largely remained unchanged for over 35 years.[1] This test relies exclusively on a person’s income and net worth. If you make enough money or have sufficient assets, you are eligible to participate, and if you do not, you generally are not eligible. The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess and bear risk has long been unsatisfactory. 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.
Moreover, businesses – particularly smaller and early stage businesses, those in geographic areas with lower concentrations of accredited investors, or founders without a wealthy friends-and-family network – are unable to seek investments from otherwise financially sophisticated individuals to access much needed seed and growth capital. When small and medium-sized businesses often, and increasingly, rely on local sources of capital, particularly at the seed and initial growth stages, these restrictions are limiting and almost certainly stifle opportunity.[2] It has been noted that these wealth-based limits on opportunity can have a disproportionate impact on minority- and women-owned businesses and other underrepresented founders.[3]
With respect to the Commission’s updates for institutional investors, we have received broad, almost universal support for our modernization efforts, including our long overdue recognition of tribal governments,[4] governmental bodies, and family wealth management vehicles as sufficiently sophisticated to participate in the private markets. In light of that support, I will focus the remainder of my comments on the individual investor test and a few issues that have been raised.
We are expanding the definition of accredited investor to include an alternative to the wealth test for natural persons — specifically, persons who hold certain professional certifications and designations and other credentials from accredited educational institutions. The Commission will be able to designate these by Order based on a number of criteria. The initial certifications include the Financial Industry Regulatory Authority, Inc. (FINRA) Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65), and Licensed Private Securities Offerings Representative (Series 82) certifications. There is no doubt persons who have successfully obtained these certifications – and maintained them in good standing – are sufficiently financially sophisticated to participate in the private markets.
During the notice and comment period, there have been several criticisms of these modest, incremental efforts to modernize our accredited investor rules that I would like to address. It has been suggested that expanding the accredited investor definition to include these clearly sophisticated persons will result in more private financings. Some think this is a positive development, some think it is negative. When you look more closely, and in particular recognize that there are many segments in the private markets and many types of private financing, it is only positive. Any expansion in private financing due to these amendments, given the limited nature of the expansion of the accredited investor definition, is likely to be most meaningful in the area of small, local business financing. Adding clearly financially sophisticated persons to the pool of persons eligible to participate in these financings is a laudable and unassailable policy goal. Of course, many have asked us to go much further in expanding the pool of eligible investors, citing, for example, the wealth gaps faced by underrepresented founders and the importance of improving access to capital for underserved businesses and communities. A number of commenters on the Commission’s efforts in the private markets space have noted that women, minority and other underrepresented entrepreneurs, as well as those outside of the coastal urban areas where traditional venture capital investment has been more focused, often do not have an existing network of wealthy friends and family and, as result, struggle to access capital.[5] Our Small Business Capital Formation Advisory Committee continues to explore how we might better serve these important segments of our markets. These are important issues to consider, and I hope that our Small Business Capital Formation Advisory Committee and our Investor Advisory Committee will continue to aid the Commission in seeking improvements to the definition and other areas of regulation that will enhance access to capital in these areas.
Some have claimed that the expansion of the definition somehow will result in more large private financings and, as a result, fewer public companies. An “upper bound” analysis of the relative potential economic impact, i.e., the potential amount of capital newly available, demonstrates this claim is unsupportable. Simply stated, the change in the definition will provide clearly sophisticated individual investors with more opportunities to invest and to diversify their investment portfolios, but it will not substantially affect aggregate capital flows among participants in private and public markets. I note here that we remain committed to, and have pursued and are continuing to pursue, measures to increase the attractiveness of our public capital markets for investors and issuers.[6]
Finally, some argue that we should increase the wealth test thresholds because, with the passage of time, the regulatory value of these thresholds have been eroded and, as a result, less sophisticated investors are eligible to participate in the private capital markets. Others claim the current thresholds are unduly restrictive and that it is unfair to exclude people based on a binary wealth test. Together, these arguments speak loudly to why the current thresholds as the sole determination for participation in these markets are unsatisfactory. It is not clear that, for example, persons with $1.5 million in net worth are any more financially sophisticated than persons meeting the current $1 million threshold or persons with $500,000 or $50,000 in net worth. This point demonstrates why simply adjusting these thresholds is not the practical question we should be attempting to address. Instead, the practical question should be, how do we improve the system we have to more closely track our mission? We do just what we are doing: we add an alternative test that more accurately tracks the Commission’s policy goal — “to identify investors that have sufficient financial sophistication to participate in investment opportunities” in the private capital markets. We do not take the current unsatisfactory test and attempt to tweak it either (1) to exclude persons who currently are eligible or (2) to include additional persons based on a wealth test that many recognize does not, in itself, meaningfully track financial sophistication.
Finally, some of those who recognize that taking away the right of current participants in this market to continue to participate is inappropriate suggest exempting currently active accredited investors from the changes, i.e., trying to devise a system that applies one set of criteria to currently active accredited investors and a different, higher wealth/income standard to new investors. For various reasons, including the costs of tracking and verification, even if this approach were appropriate (and for the reason discussed here, I do not believe it is), it would be unworkable. In years to come, future Commissions, with the benefit of the additional means of demonstrating financial sophistication provided by today’s actions, may revisit the wealth tests and modify them with the knowledge that, given the alternative tests we are adopting today (which investors can over time take steps to satisfy), those modifications would be less disruptive and more fair to individual investors. However, today, we are not in that position. And here, I thank the staff and my colleagues for recognizing that modest, thoughtful updates that bring our rules more in line with our mission and long-standing policy objectives will have returns today and in the future, including by increasing the Commission’s ability to act as circumstances change.[7] This is another fine example of retrospective review and modernization furthering each aspect of our tripartite mission.
[1] In 1988, the definition was modified to include a joint income component. Regulation D Revisions, Release No. 33-6758 (Mar. 3, 1988) [53 FR 7866 (Mar. 10. 1988)]. In 2011, the definition was modified to codify a statutory requirement to exclude the value of the investor’s primary residence from the calculation of net worth. Net Worth Standard for Accredited Investors, Release No. 33-9287 (Dec. 21, 2011) [76 FR 81793 (Dec. 29, 2011)].
[2] PitchBook, The Venture Climate, presentation at the Small Business Capital Formation Advisory Committee Meeting (Feb. 4, 2020), at 9, available at https://www.sec.gov/spotlight/sbcfac/2020-02-04-presentation-pitchbook-venture-climate.pdf; Catherine Mott, statement at the Small Business Capital Formation Advisory Committee Meeting (Nov. 12, 2019), at 74-75, transcript available at https://www.sec.gov/info/smallbus/acsec/sbcfac-transcript-111219.pdf.
[3] See e.g., Alicia Robb, Access to Capital among Young Firms, Minority-owned Firms, Women-owned Firms, and High-tech Firms, Small Business Administration Office of Advocacy (April 2013) (“African-American wealth levels are just 8 percent of non-minority wealth levels, and Hispanic wealth levels are just 12 percent of non-minority wealth levels.”)
[4] See letter from Southern Ute Indian Tribe dated Mar. 3, 2020 and Native American Finance Officers Association (NAFAO) dated Mar. 16, 2020. In addition, on July 18, 2019, prior to the Commission’s proposed amendments to the accredited investor definition, Chairman Clayton met with Dante Desiderio, Executive Director, NAFAO.
[5] See, e.g., letters from Brandon Andrews dated May 1, 2020 (noting the lack of equitable access to capital or investment opportunities for women and communities of color in the current Accredited Investor Definition) (available at Comments on Proposed Rule: Amending the “Accredited Investor” Definition, https://www.sec.gov/comments/s7-25-19/s72519.htm); NextSeed Securities LLC dated June 1, 2020 (“Often, underrepresented communities simply do not have the “pre-existing relationships” with accredited investors and do not know how to make those connections independently …”), and OpenDeal, Inc. (d/b/a Republic) dated June 1, 2020 (“female, minority, veteran and immigrant entrepreneurs, as well as entrepreneurs based in middle America, often struggle to obtain exposure to and capital from traditional venture investors”) (both available at Comments on Proposed Rule: Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, https://www.sec.gov/comments/s7-05-20/s70520.htm). See also Arlan Hamilton, Investing in the Underestimated, 39th Annual Small Business Forum, June 18, 2020 (2020 Forum), transcript available at https://www.sec.gov/file/06182020-small-business-forum-transcript.pdf and the archived recording is available at https://www.sec.gov/video/webcast-archive-player.shtml?document_id=061820sbf (noting that broadening the accredited investor definition would lead to funding “more of these companies that are having so much trouble getting funding because of systemic biases”); Erica Duignan Minnihan and Samara Mejia Hernandez, Empowering Women Entrepreneurs, 2020 Forum (discussing the challenges that many women and minority founders face if they do not have an existing network of wealthy friends and family and the positive impact of expanding access to capital for female and minority founders to create change within diverse communities).
[6] See, e.g., Testimony on “Oversight of the Securities and Exchange Commission” Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, available at https://www.sec.gov/news/testimony/testimony-clayton-2019-12-10.
[7] In particular, I would like to acknowledge the following staff members for their contribution to this effort: From the Division of Corporation Finance: Bill Hinman, Michael Seaman, Betsy Murphy, Jennifer Zepralka, and Charlie Guidry. From the Division of Investment Management: Dalia Blass, Sarah Ten Siethoff, Melissa Gainor, Jennifer Songer, and Lawrence Pace. From the Office of the General Counsel: Bob Stebbins, Bryant Morris, Connor Raso, Cathy Ahn, and Natalie Shioji. From the Division of Economic and Risk Analysis: S.P. Kothari, Hari Phatak, Malou Huth, Vlad Ivanov, Lauren Moore, Andrew Glickman, and Mattias Nilsson.
