The Securities and Exchange Commission made some small changes to the definition of “accredited investor” last week. The changes had been first proposed last December.
The definition of “accredited investor” is at the nexus of the Securities and Exchange Commission’s missions: (1) to protect investors, (2) to maintain fair, orderly, and efficient markets, and (3) to facilitate capital formation. If you’re an accredited investor you have access to private offerings. That enables capital formation. Private offerings are not subject to review by the SEC so they have fewer protections in place for investors. The commissioners were split on their votes to approve the changes.
Lots of arguments around the accredited investor definition are about an investor’s ability to assess risk in making the investment. I’ve long argued that the risk with a private placement is not the risk of loss, but the risk of liquidity. Some private placements are very risky and some are not. All private placements are less liquid than publicly traded securities. Tesla is at a crazy price right now, but you can sell and exit out of your position in minutes. You may not be able to exit from a private placement position for years.
The big news in the changes in the definition are the items that are missing. There were no changes to the wealth or income levels for qualification. Those levels have been unchanged for decades, broadening the pool of accredited investors with inflation.
The changes to the definition really just make some small expansions.
The SEC added a new category to the definition that permits qualification based on certain professional certifications, designations or credentials. In conjunction with the changes, the SEC designated holders in good standing of the Series 7, Series 65, and Series 82 licenses as accredited investors. These are deemed as individuals with an ability to assess risk.
For private funds, there is an application of the “knowledgeable employee” definition over to accredited investor status. The SEC established Rule 3C-5 to allow “knowledgeable employees” to invest in their company’s private fund without having to be a “qualified purchaser”. The rule also exempts these knowledgeable employees from the 100 investor limit under the Section 3(c)(1) exemption from the Investment Company Act. However, the knowledgeable employee had to separately qualify as an accredited investor. This rule change covers that gap.
In act of progressive politics, the SEC added 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 term spousal equivalent shall mean a cohabitant occupying a relationship generally equivalent to that of a spouse.”
There were additional marginal expansions for some investment entities.
Sources:
- Amending the “Accredited Investor” Definition Release Nos. 33-10824; 34-89669
- SEC Modernizes the Accredited Investor Definition
- Proposed Changes to Accredited Investor Definition
- Statement on Modernization of the Accredited Investor Definition – Chairman Clayton
- Statement on Amending the “Accredited Investor” Definition – Commissioner Hester M. Peirce
- Commissioner Roisman Statement on Amending the “Accredited Investor” Definition
- Joint Statement on the Failure to Modernize the Accredited Investor Definition – Commissioners Allison Herren Lee and Caroline Crenshaw
- SEC Gives More Investors Access to Private Equity, Hedge Funds – Wall Street Journal
- More Guidance on Knowledgeable Employee Exemption for Private Funds