The US Supreme Court ruled on same sex marriages and removed the broad federal definition of marriage that applies to over a thousand laws and regulations. Decision in US v. Windsor (.pdf) One of those regulations is from the Securities and Exchange Commission and affects fundraising for private funds and other private placements.
One of the standards for private placements of securities is that an investor generally needs to meet the definition of “accredited investor.” For an individual that means a (1) net worth, excluding the primary residence, of $1 million, or (2) annual income in excess of $200,000 in each of the two most recent years or joint income with a spouse in excess of $300,000.
Section 3 of the Defense of Marriage Act mandated that the word “spouse” refer only to a person of the opposite sex who is a husband or a wife.” 1 U.S.C. § 7 (1997)
Less than 10 years ago, the Massachusetts Supreme Judicial Court went through a laundry list of legal rights that couples enjoy once they are married. In the landmark Goodridge decision, that court decided that “spouse” should not be limited to a man and a woman. It affects a broad spectrum of rights granted by the government to people who are married.
The US Supreme Court decided that Section 3 of the Defense of Marriage Act is unconstitutional. Therefore, the accredited investor definition’s use of the word “spouse” is no longer restricted by DOMA to a person of the opposite sex who is a husband or a wife.
In the states that allow same-sex marriage, an issuer should now be able to allow a same-sex married couple to combine their income to meet the standard. I don’t think the SEC needs to take any action for this to happen.
In states that allow civil unions, the answer is a bit murkier and depends on the rights granted under state law. The civil union law would need to deem the two participants to be “spouses.” That is exactly what Illinois did in its civil union law:
“Party to a civil union” means a person who has established a civil union pursuant to this Act. “Party to a civil union” means, and shall be included in, any definition or use of the terms “spouse”, “family”, “immediate family”, “dependent”, “next of kin”, and other terms that denote the spousal relationship, as those terms are used throughout the law. SB1716
What is even murkier is a married couple who move to a state that does not recognize same sex marriage. Are they still “spouses” if not recognized by their state of residence? Justice Scalia raises this issue in his dissent.
Whether you agreed with DOMA or not, it made a very bright line test for “spouse”. That line is now more complicated for determining if a potential investor is an “accredited investor.”
This may become even more complicated when the SEC finally issues the regulation that lifts the ban on general solicitation and advertising. The new regulation will require a firm to take reasonable steps to determine that an investor is accredited if it wants to engage in general advertisement or solicitation. It will be interesting to see if the SEC includes something on this issue.
Given the SEC’s huge rulemaking backlog, I doubt they will make a separate statement on same-sex marriages under securities law. The SEC could tuck something into the advertising rule since it is already in the works. Perhaps the SEC was waiting for the Windsor case to be decided.
Sources:
- Decision in US v. Windsor (.pdf)
- Liveblogging Supreme Court same-sex marriage cases: What today’s rulings mean for angel investing and the startup financing ecosystem
- The accredited investor definition, after the Supreme Court strikes down DOMA
- A Story by Joe Wallin
- “Spouse” Abuse: Regulation D And The Defense Of Marriage (.pdf) by Ryan J. Kretschmer, Walton International Group in the Blue Sky Bugle
- United States v. Windsor on the SCOTUS Blog
- Goodridge v. Dept. of Public Health (.pdf)
- Same Sex Marriage and Accredited Investors
- The New Accredited Investor Standard – prior post
These are some interesting issues, but how much do you think they are likely to matter in practice? For instance, most offerings to accredited investors rely on the investors’ self reporting as to their status. Under Rule 501, if an issuer “reasonably believes” that an investor meets one of the accredited investor standards, then they are an accredited investor. In making the determinate as to whether the investor is accredited, if an investor includes the assets of their domestic partner while living in a civil union state, or includes the assets of a spouse previously married in a state permitting same sex marriage while the couple lives in a state prohibiting same sex marriage, I’m not sure there is much impact from a securities law perspective, unless the issuer is intimately aware of the couple’s finances.
Perhaps the answer is somewhat different under the proposed 506(c) offerings, but for now, these borderline cases are unlikely to make a difference to most issuers.
I hope you are right but I do think 506(c) will eventually become the de facto standard for most 506 offerings, at least for startups, and so verification is really a big deal. Maybe the verification rules could say, “look, all this stuff about jumping through hoops to check what people make or how much net worth they have, yes, you have to do that, but whether someone is a spouse or not, you just ask them and follow what they say.”
That’s interesting, I’ve always figured that most people would stick with 506(b) over 506(c) since I think verification is more intrusive than the prohibition on general solicitation (and whatever other strings the SEC adds to 506(c); we’ll find out more tomorrow I guess).
I think many firms are leaning towards 506(c) so they can avoid accidentally blowing up a private placement by talking to the press or at a conference. But that all depends on whatever additional overhead the SEC imposes. We’ll find out shortly.
Out of curiosity, what are your thoughts now on what will become the de facto standard (506(b) or 506(c)) after last thursday’s regs? I think Doug is right in that the institutional issuers like hedge funds and PE funds will be ok with the increased compliance burden, but for startups, right now I’m leaning on recommending to most of my startup clients to stay put with 506(b).
I agree. I think these instances will be at the margin. Even more so when California once again recognizes non-heterosexual marriages.
I have heard of cases where a potential investor has asked the question of the issuer about the standard and been disappointed with the answer. For example see: A Story by Joe Wallin
I agree with you that the 506(c) rule will have a bigger impact on the questionnaires. To the extent there is some additional requirement, this could be a factor.