Small Entity Compliance Guide[1]

On August 26, 2020, the U.S. Securities and Exchange Commission (“Commission”) adopted amendments to the definition of “accredited investor” under the Securities Act of 1933 (“Securities Act”). The amendments update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in private capital markets. The amendments are effective December 8, 2020.

What changes were made by the amendments?

1. Add categories of natural persons eligible to qualify as accredited investors.

Professional certifications and designations and other credentials

The amendments created an accredited investor category for individual investors who hold, in good standing, certain professional certifications and designations and other credentials designated by the Commission as qualifying for accredited investor status. The Commission designated three certifications and designations administered by the Financial Industry Regulatory Authority, Inc. as qualifying for accredited investor status:

• Licensed General Securities Representative (Series 7);
• Licensed Investment Adviser Representative (Series 65); and
• Licensed Private Securities Offerings Representative (Series 82).

Individuals holding any of these three designations in good standing can qualify as accredited investors. Whether a person holds one of the designations in good standing is specific to that designation, and persons seeking accredited investor status under this category should consult FINRA rules and any state rules applicable to them. For example, a person seeking accredited investor status by passing the Series 65 exam would also need to be licensed as an investment adviser representative in her state and would need to comply with all state-specific licensing requirements (e.g., paying annual fees, etc.).

The Commission may designate in the future additional qualifying professional certifications, designations, and other credentials by order. Requests for Commission consideration, which must address how a particular certification, designation, or credential satisfies the nonexclusive list of attributes set forth in the new rule, may be submitted at investorcredentials@sec.gov.

Knowledgeable employees

The amendments also created an accredited investor category for individual investors who are knowledgeable employees of certain private funds. To qualify as an accredited investor under this category, an investor must be a “knowledgeable employee,” as defined in Rule 3c–5(a)(4) under the Investment Company Act of 1940 (the “Investment Company Act”), of the private fund issuer of the securities being offered or sold. This includes directors and certain executive officers of the private fund, or of an affiliated person of the private fund that manages the investment activities of the private fund (“affiliated management person”). This also includes employees who participate in the investment activities of the private fund or other private funds or investment companies managed by the affiliated management person.

A private fund issuer is an issuer that would be an investment company, as defined in section 3 of such the Investment Company Act, but for the exclusion provided by either section 3(c)(1) or section 3(c)(7) of such Act.

A natural person qualifying as an accredited investor based on her status as a knowledgeable employee is an accredited investor only for offerings by the private fund and other private funds managed by their employer. She cannot use her status as a knowledgeable employee to qualify as an accredited investor to invest in other offerings.

Family clients of family offices

A natural person may also qualify as an accredited investor based on her status as a family client of a family office. To qualify, an investor must:

• come within the definition of “family client” in rule 202(a)(11)(G)–1 under the Investment Advisers Act of 1940 (the “Advisers Act”),
• be a family client of a family office that itself qualifies as an accredited investor, and
• have her investment be directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.

See the discussion below of the “family office” category of accredited investor for additional information.

2. Add categories of entities eligible to qualify as accredited investors.

The amendments created several accredited investor categories for entities:

• investment advisers registered with the Commission,
• state-registered investment advisers,
• exempt reporting advisers,
• rural business investment companies,
• limited liability companies with more than $5 million in assets,
• certain family offices and family clients, and
• entities owning investments in excess of $5 million.

Investment advisers

An investment adviser may qualify for accredited investor status if it is either registered with the Commission, registered with a state, or is relying on an exemption from registering with the Commission under section 203(l) or (m) of the Advisers Act.

Rural business investment companies

Rural business investment companies, as defined in defined in Section 384A of the Consolidated Farm and Rural Development Act, qualify as accredited investors under the amendments.

Limited liability companies

The amendments codified a long-standing staff interpretation allowing limited liability companies with more than $5 million in assets to qualify as accredited investors. Such limited liability companies may not be formed for the specific purpose of acquiring the securities offered.

Family offices and entities that are family clients

To qualify as an accredited investor, a family office:

• must come within the definition of “family office” in Rule 202(a)(11)(G)–1 under the Advisers Act,
• must have assets under management in excess of $5 million,
• cannot be formed for the specific purpose of acquiring the securities offered, and
• must have its prospective investments be directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment.

Similar to family clients who are natural persons, to qualify as an accredited investor based on status as a family client, an entity must (i) come within the definition of “family client” in rule 202(a)(11)(G)–1 under the Advisers Act, (ii) be a family client of a family office that itself qualifies as an accredited investor, and (iii) have its investment be directed by the family office.

All other entities meeting an investments test

The amendments also created a catch all for entities:

• not already considered accredited investors under the definition,
• that were not formed for the specific purpose of acquiring the securities offered, and
• that own investments in excess of $5 million.

“Investments” is defined in rule 2a51–1(b) under the Investment Company Act to include securities; real estate, commodity interests, physical commodities, and non-security financial contracts held for investment purposes; and cash and cash equivalents.

Other Resources

The adopting release for these amendments can be found on the Commission’s website at https://www.sec.gov/rules/final/2020/33-10824.pdf.

Contacting the SEC

Questions on the amendments and on other Commission regulatory matters concerning small companies may be directed to the Division’s Office of Small Business Policy at (202) 551-3460 or smallbusiness@sec.gov. The Commission’s Division of Investment Management’s Chief Counsel’s Office is also available to assist small entities and others with questions regarding the rule amendments. You may contact the Office for this purpose at 202-551-6825 or IMOCC@sec.gov.

[1] This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains the rules adopted by the Commission, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.