SEC Expands Eligible Participation in Private Offerings
By: Jonathan Wolnik
Seeking to protect private investors, the Securities and Exchange Commission (SEC) has long imposed stringent restrictions on “accredited investor” qualifications. This was done to control access to private offerings exempted from SEC regulation, in hopes of preventing personal losses to those investors not in a position to protect themselves. Perhaps the SEC’s paternalistic approach is softening because at the end of August, the SEC revised the accredited investor definition, thereby allowing more investors to qualify and participate in private offerings.
Who Was Qualified as an Accredited Investor
The SEC regulates public investment opportunities and generally only allows certain defined individuals (accredited investors) to subscribe to private investment opportunities. Because such private offerings are exempt from SEC oversight, they are deemed to be of higher risk and thus are “reserved” for investors the SEC considers better suited to protect themselves. Historically, such investors have generally been defined by their accumulation of significant wealth (greater than $1 million) or by earning significant dollars (greater than $200,000) annually with the ongoing expectation that such earning power shall continue.
The SEC also considers a person with certain leadership roles in the entity offering the private investment as accredited. The SEC assumed that high earners and the wealthy must be sophisticated and can afford to hire private lawyers or accountants to help them make prudent private investment decisions, thereby offering “self-protection” to the investor. Otherwise, the definition allowed for “insiders” who were deemed to have access to all necessary information to evaluate the risk of the private investment. Access to such information reduces the need to rely on the SEC for investor protection.
Who Now Qualifies as An Accredited Investor
Considering this scope of permitted investors, the SEC’s accredited investor definitions excluded certain people with professional expertise who should also be capable of making prudent investment decisions, despite lacking the required personal wealth. To remedy this disparity, the SEC expanded its accredited investor definition to include those with professional certifications and credentials demonstrating knowledge, proficiency and competence with private investments. Individuals holding Series 7, 65 or 82 licenses now, by definition, qualify as accredited investors. Further, “knowledgeable employees” of private funds automatically qualify as accredited investors, as well, which includes executive officers, directors, trustees, general partners, board members, investment managers, or other employees (except those who exclusively perform clerical, administrative or secretarial functions) who have participated in investment activities within the fund for at least the prior 12 months.
Further, the new rule enumerates other explicitly recognized accredited investors, such as: (1) Investment Advisors registered under the Investment Advisers Act; (2) LLCs that satisfy certain other accredited investment requirements; and (3) “family offices” that have at least $5 million in assets under management and have a designated, knowledgeable individual to manage the prospective investment. In amending the accredited investor definition, the SEC considered including additional options, such as broker-dealer customers, other credentialed professionals, or allowing individuals to self-certify they are financially sophisticated. These proposals were ultimately rejected by the SEC because of its continued focus on controlling what it believed to be a pool of accredited investors that are truly and demonstrably in a position to protect themselves.
Despite the rule expansion, private investments remain heavily regulated and often can be challenging to navigate. They will always present serious risk. Those offering, or seeking to subscribe to, private investments should be working closely with counsel to ensure compliance and to make the best-informed decisions possible.
Jonathan C. Wolnik is an associate attorney with Cleveland, OH-based McCarthy, Lebit, Crystal & Liffman.
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