[Federal Register Volume 85, Number 10 (Wednesday, January 15, 2020)]
[Proposed Rules]
[Pages 2574-2613]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28304]
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Vol. 85
Wednesday,
No. 10
January 15, 2020
Part IV
Securities and Exchange Commission
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17 CFR Parts 230 and 240
Amending the ``Accredited Investor'' Definition; Proposed Rule
Federal Register / Vol. 85 , No. 10 / Wednesday, January 15, 2020 /
Proposed Rules
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SECURITIES AND EXCHANGE COMMISSION
17 CFR PARTS 230 and 240
[Release Nos. 33-10734; 34-87784; File No. S7-25-19]
RIN 3235-AM19
Amending the ``Accredited Investor'' Definition
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: We are proposing amendments to the definition of ``accredited
investor'' in our rules to add new categories of qualifying natural
persons and entities and to make certain other modifications to the
existing definition. The proposed amendments are intended to update and
improve the definition in order to identify more effectively
institutional and individual investors that have the knowledge and
expertise to participate in our private capital markets and therefore
do not need the additional protections of registration under the
Securities Act of 1933. We are also proposing amendments to the
qualified institutional buyer definition in Rule 144A under the
Securities Act that would expand the list of entities that are eligible
to qualify as qualified institutional buyers.
DATES: Comments should be received on or before 60 days after
publication in the Federal Register.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-25-19 on the subject line.
Paper Comments
Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-25-19. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method of submission. The Commission will post all comments on the
Commission's website (http://www.sec.gov/rules/proposed.shtml).
Comments also are available for website viewing and printing in the
Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549-1090 on official business days between the hours of 10:00 a.m.
and 3:00 p.m. Persons submitting comments are cautioned that we do not
redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly.
We or the staff may add studies, memoranda, or other substantive
items to the comment file during this rulemaking. A notification of the
inclusion in the comment file of any such materials will be made
available on our website. To ensure direct electronic receipt of such
notifications, sign up through the ``Stay Connected'' option at
www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Charles Kwon, Senior Counsel, Office
of Rulemaking, or Charlie Guidry, Special Counsel, Office of Small
Business Policy, at (202) 551-3460, Division of Corporation Finance;
Jennifer Songer, Branch Chief, or Lawrence Pace, Senior Counsel, at
(202) 551-6999, Investment Adviser Regulation Office, Division of
Investment Management; U.S. Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are proposing amendments to 17 CFR
230.144A (``Rule 144A''), 17 CFR 230.163B (``Rule 163B''), 17 CFR
230.215 (``Rule 215''), and 17 CFR 230.501 (``Rule 501'') of 17 CFR
230.500 through 230.508 (``Regulation D'') under the Securities Act of
1933 (``Securities Act''); \1\ and 17 CFR 240.15g-1 (``Rule 15g-1'')
under the Securities Exchange Act of 1934 (``Exchange Act'').\2\
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\1\ 15 U.S.C. 77a et seq.
\2\ 15 U.S.C. 78a et seq.
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Table of Contents
I. Introduction
II. Proposed Amendments to the Accredited Investor Definition
A. Background
B. Adding Categories of Natural Persons Who Qualify as
Accredited Investors
1. Professional Certifications and Designations and Other
Credentials
2. Knowledgeable Employees of Private Funds
3. Proposed Note to Rule 501(a)(5)
C. Adding Categories of Entities That Qualify as Accredited
Investors
1. Registered Investment Advisers
2. Rural Business Investment Companies
3. Limited Liability Companies
4. Other Entities Meeting an Investments-Owned Test
5. Proposed Note to Rule 501(a)(8)
6. Certain Family Offices and Family Clients
D. Permit Spousal Equivalents To Pool Finances for the Purposes
of Qualifying as Accredited Investors
E. Proposed Amendment to Rule 215
F. Proposed Amendment to Rule 163B
G. Proposed Amendment to Exchange Act Rule 15g-1
III. Additional Requests for Comment on the Accredited Investor
Definition
IV. Proposed Amendment to the Qualified Institutional Buyer
Definition
V. Implications for Other Contexts
VI. General Request for Comment
VII. Economic Analysis
A. Introduction
B. Broad Economic Effects
C. Baseline and Affected Parties
D. Anticipated Economic Effects
1. Potential Benefits to Issuers
2. Potential Benefits to Investors
3. Potential Costs to Issuers
4. Potential Costs to Investors
5. Variation in Economic Effects
6. Competition, Efficiency, and Capital Formation
7. Alternatives
VIII. Paperwork Reduction Act
IX. Small Business Regulatory Enforcement Fairness Act
X. Initial Regulatory Flexibility Analysis
A. Reasons for, and Objectives of, the Proposed Action
B. Legal Basis
C. Small Entities Subject to the Proposed Rule
D. Projected Reporting, Recordkeeping and Other Compliance
Requirements
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
G. Request for Comment
XI. Statutory Authority and Text of Proposed Rule Amendments
I. Introduction
On June 18, 2019, the Commission issued a concept release that
solicited public comment on possible ways to simplify, harmonize, and
improve the exempt offering framework under the Securities Act of 1933
to promote capital formation and expand investment opportunities while
maintaining appropriate investor protections.\3\ In the Concept
Release, the Commission requested comments on possible approaches to
amending the definition of ``accredited investor'' in Rule 501(a) of
Regulation D. This definition is a central component of several
exemptions from registration such as Rules 506(b) and 506(c) of
Regulation D, and plays an important role in other federal and state
securities law contexts. Qualifying as an accredited investor is
significant because accredited investors may, under Commission rules,
participate in investment opportunities that are
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generally not available to non-accredited investors, such as
investments in private companies and offerings by certain hedge funds,
private equity funds, and venture capital funds.
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\3\ Concept Release on Harmonization of Securities Offering
Exemptions, Release No. 33-10649 (June 18, 2019) [84 FR 30460 (June
26, 2019)] (``Concept Release'').
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In view of the significance of the accredited investor definition
in the exempt offering framework, we are proposing to amend the
accredited investor definition as an initial step in a broader effort
to consider ways to harmonize and improve this framework. We believe
that this proposal to update the accredited investor definition would
provide a foundation for our ongoing efforts to assess whether our
exempt offering framework, as a whole, is consistent, accessible, and
effective for both issuers and investors. In addition to these proposed
rule amendments, we are continuing to evaluate the comments received on
the Concept Release in connection with possible future rulemaking
proposals relating to the exemptions from registration under the
Securities Act.
The Concept Release was preceded by a staff report \4\ on the
accredited investor definition issued in December 2015. The 2015 Staff
Report examined the background and history of the definition and
considered comments and recommendations from the public, the
Commission's Investor Advisory Committee,\5\ the Commission's Advisory
Committee on Small and Emerging Companies,\6\ and the 2014 SEC
Government-Business Forum on Small Business Capital Formation.\7\ The
2015 Staff Report also presented staff recommendations on amending the
definition and analyzed the impact of potential approaches to amending
the definition on the pool of accredited investors. The Commission
staff prepared the report pursuant to Section 413(b)(2)(A) of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank
Act''),\8\ which directs the Commission to review the accredited
investor definition as the term relates to natural persons at least
once every four years to determine whether the definition ``should be
adjusted or modified for the protection of investors, in the public
interest, and in light of the economy.'' \9\ The Commission received
over 50 comment letters on the 2015 Staff Report and subsequently
received recommendations on possible revisions to the accredited
investor definition from the Advisory Committee on Small and Emerging
Companies \10\ and the annual SEC Government-Business Forum on Small
Business Capital Formation.\11\
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\4\ See Report on the Review of the Definition of ``Accredited
Investor'' (Dec. 18, 2015) (``2015 Staff Report''), available at
https://www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12-18-2015.pdf.
\5\ See Recommendation of the Investor as Purchaser Subcommittee
and the Investor Education Subcommittee of the Investor Advisory
Committee: Accredited Investor Definition (Oct. 9, 2014), (the
``2014 Investor Advisory Committee Recommendation''), available at
http://www.sec.gov/spotlight/investor-advisory-committee-2012/accredited-investor-definition-recommendation.pdf.
\6\ See Advisory Committee on Small and Emerging Companies:
Recommendations Regarding the Accredited Investor Definition (March
9, 2015) (the ``2015 ACSEC Recommendations''), available at http://www.sec.gov/info/smallbus/acsec/acsecaccredited-investor-definition-recommendation-030415.pdf.
\7\ See Final Report of the 2014 SEC Government-Business Forum
on Small Business Capital Formation (May 2015), available at http://www.sec.gov/info/smallbus/gbfor33.pdf.
\8\ Public Law 111-203, 124 Stat. 1376 (2010).
\9\ Section 413(b)(2)(A) states that this Commission review must
be conducted not earlier than four years after the enactment of the
Dodd-Frank Act and not less frequently than once every four years
afterward.
\10\ See Advisory Committee on Small and Emerging Companies:
Recommendations Regarding the Accredited Investor Definition (July
20, 2016) (the ``2016 ACSEC Recommendations''), available at https://www.sec.gov/info/smallbus/acsec/acsec-recommendations-accredited-investor.pdf.
\11\ Each of the Final Reports of the 2016, 2017, and 2018 SEC
Government-Business Forums on Small Business Capital Formation
included a recommendation that the Commission maintain the monetary
thresholds for accredited investors and expand the categories of
qualification for accredited investor status based on various types
of sophistication such as education, experience, and training. See
Final Report of the 2016 SEC Government-Business Forum on Small
Business Capital Formation (March 2017) (the ``2016 Small Business
Forum Report''), available at https://www.sec.gov/info/smallbus/gbfor35.pdf; Final Report of the 2017 SEC Government-Business Forum
on Small Business Capital Formation (March 2018) (the ``2017 Small
Business Forum Report''), available at https://www.sec.gov/files/gbfor36.pdf; and Final Report of the 2018 SEC Government-Business
Forum on Small Business Capital Formation (June 2019) (the ``2018
Small Business Forum Report''), available at https://www.sec.gov/info/smallbus/gbfor37.pdf.
The Final Report of the 2019 SEC Government-Business Forum on
Small Business Capital Formation included a recommendation that the
Commission should revise the accredited investor definition as
follows: (1) For natural persons, in addition to the income and net
worth thresholds in the definition, add a sophistication test as an
additional way to qualify; (2) provide tribal governments parity
with state governments; and (3) revise the dollar amounts to scale
for geography, lowering the thresholds in states/regions with a
lower cost of living. See Final Report of the 2019 SEC Government-
Business Forum on Small Business Capital Formation (December 2019)
(the ``2019 Small Business Forum Report''), available at https://www.sec.gov/files/small-business-forum-report-2019.pdf.
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Many of the comments submitted in response to the Concept Release
\12\ urged the Commission to expand the accredited investor
definition.\13\ Other commenters opposed changing the definition or
stated that the Commission should narrow the definition,\14\ while a
few commenters recommended that the Commission eliminate the definition
altogether.\15\ Commenters expressed a range of views on whether the
Commission should amend the financial thresholds currently in the
accredited investor definition,\16\ and a number of commenters urged
the Commission to maintain objective standards in the
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definition.\17\ Some commenters suggested that the Commission harmonize
the accredited investor definition with the definitions of ``qualified
purchaser'' under the Investment Company Act of 1940 (the ``Investment
Company Act''), ``qualified client'' under the Investment Advisers Act
of 1940 (the ``Advisers Act''), and/or ``qualified institutional
buyer'' as defined in Rule 144A under the Securities Act.\18\
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\12\ Unless otherwise indicated, comments cited in this release
are to comment letters received in response to the Concept Release,
which are available at https://www.sec.gov/comments/s7-08-19/s70819.htm.
\13\ See, e.g., letters from Federal Regulation of Securities
Committee, Business Law Section of the American Bar Association
dated October 16, 2019 (``ABA FR of Sec. Comm. Letter''); Island
Mountain Development Group dated September 24, 2019 (``IMDG
Letter''); Association for Corporate Growth dated September 24, 2019
(``ACG Letter''); Investments and Wealth Institute dated September
12, 2019 (``IWI Letter''); Securities Regulation Committee, Business
Law Section of the New York State Bar Association dated October 18,
2019 (``Sec. Reg. Comm. of NY St. B.A. Letter''); Small Business
Investor Alliance dated September 25, 2019 (``2019 SBIA Letter'');
BlackRock, Inc. dated September 24, 2019 (``BlackRock Letter'');
Artivest Holdings, Inc. dated October 8, 2019 (``Artivest Letter'');
EquityZen Inc. dated September 30, 2019 (``EquityZen Letter'');
Alfonso Ceja dated October 15, 2019 (``A. Ceja Letter''); CoinList
dated September 26, 2019 (``CoinList Letter''); H. Konings et al.
dated September 24, 2019 (``H. Konings et al. Letter''); Institute
for Portfolio Alternatives dated September 24, 2019 (``IPA
Letter''); Jeff Thomas dated September 24, 2019 (``J. Thomas
Letter''); McCarter & English LLP dated September 24, 2019
(``McCarter & English Letter''); Center for Capital Markets
Competitiveness of the U.S. Chamber of Commerce dated September 24,
2019 (``CCMC Letter''); CFA Institute dated September 24, 2019
(``CFA Institute Letter''); Marketplace Lending Association dated
September 23, 2019 (``MLA Letter''); Funding Circle dated September
23, 2019 (``Funding Circle Letter''); Bridgeport Financial
Technology dated September 20, 2019 (``Bridgeport Letter''); Jor Law
dated July 6, 2019; Kyle Sonlin dated June 26, 2019 (``K. Sonlin
Letter''); John Tapp dated June 19, 2019 (``J. Tapp Letter'');
Private Investor Coalition dated September 24, 2019 (``2019 PIC
Letter''); California Municipal Treasurers Association dated
September 20, 2019 (``CMTA Letter''); Native American Finance
Officers Association dated September 12, 2019 (``NAFOA Letter'');
Investment Adviser Association dated October 18, 2019 (``IAA
Letter''); Managed Funds Association and Alternative Investment
Management Association dated September 24, 2019 (``MFA and AIMA
Letter''); Crowdfunding Professionals Association, Legislative &
Regulatory Affairs Division, dated October 15, 2019 (``CfPA
Letter''); Joseph L. Schocken dated September 24, 2019 (``J.
Schocken Letter''); Alternative & Direct Investment Securities
Association dated September 24, 2019 (``ADISA Letter''); Jeff
LaBerge dated September 6, 2019 (``J. LaBerge Letter''); and
Association of Online Investment Platforms dated July 5, 2019
(``AOIP Letter'').
\14\ See, e.g., letters from Consumer Federation of America
dated October 1, 2019 (``Consumer Federation Letter'') and Forum for
U.S. Securities Lawyers in London dated September 24, 2019.
\15\ See, e.g., letters from Nathan Eames dated September 1,
2019 and Andrew Deville dated June 19, 2019.
\16\ See infra Section III.
\17\ See, e.g., ABA Fed. of Sec. Reg. Comm. Letter; letter from
Securities Industry and Financial Markets Association dated
September 24, 2019 (``SIFMA Letter''); BlackRock Letter; and MFA and
AIMA Letter.
\18\ See, e.g., ABA FR of Sec. Comm. Letter; IAA Letter; Sec.
Reg. Comm. of NY St. B.A. Letter; SIFMA Letter; BlackRock Letter;
and letter from Shartsis Friese LLP dated September 24, 2019
(``Shartsis Friese Letter'').
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Commenters on the Concept Release offered a number of suggestions
for expanding the accredited investor definition to provide natural
persons and entities with additional means of qualifying for accredited
investor status. Some commenters suggested that the Commission amend
the definition to deem natural persons with additional measures of
financial sophistication, other than annual income or net worth,
eligible for accredited investor status, such as professional
certifications,\19\ prior experience in investing in securities,\20\
status as a ``knowledgeable employee'' as defined in 17 CFR 270.3c-5
under the Investment Company Act (``Rule 3c-5''),\21\ or an accredited
investor examination.\22\ Several commenters urged the Commission to
amend the accredited investor definition to include natural persons or
entities that are advised by a financial professional, such as a
registered investment adviser that acts as a fiduciary in making the
investment,\23\ while other commenters opposed this view.\24\
Commenters also recommended that the Commission expand the accredited
investor definition to include family offices and clients of family
offices, as defined in 17 CFR 275.202(a)(11)(G)-1 under the Advisers
Act (``Rule 202(a)(11)(G)-1''),\25\ registered investment advisers,\26\
entities with investments over a certain threshold (e.g., $5
million),\27\ Indian tribes,\28\ and certain state and local
governments.\29\
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\19\ See infra Section II.B.1.
\20\ See, e.g., CCMC Letter; letter from Institutional Capital
Network dated September 24, 2019 (``iCapital Network Letter''); CFA
Institute Letter; and letter from Charlie Uchill dated August 9,
2019 (``C. Uchill Letter'').
\21\ See infra Section II.B.2.
\22\ See, e.g., ACG Letter; J. Thomas Letter; CCMC Letter; MLA
Letter; Funding Circle Letter; letter from Hedge Fund Association
dated September 23, 2019 (``HFA Letter''); and letter from Wefunder
dated September 13, 2019 (``Wefunder Letter'').
\23\ See, e.g., IAA Letter; Artivest Letter; letter from
MarketPlus Capital Company dated October 8, 2019; EquityZen Letter;
2019 SBIA Letter; IPA Letter; BlackRock Letter; iCapital Network
Letter; letter from Davis Polk & Wardwell LLP dated September 24,
2019 (``Davis Polk Letter''); letter from Iownit Capital and
Markets, Inc. dated September 24, 2019 (``Iownit Letter''); and
Wefunder Letter.
\24\ See, e.g., letters from Public Investors Advocate Bar
Association dated September 24, 2019 (``PIABA Letter''); Investment
Company Institute dated September 24, 2019 (``ICI Letter''); and
Angel Capital Association dated September 23, 2019 (``ACA Letter'').
\25\ See infra Section II.C.6.
\26\ See infra Section II.C.1.
\27\ See infra Section II.C.4.
\28\ See, e.g., letter from Rosebud Economic Development
Corporation dated September 24, 2019 (``REDCO Letter''); IMDG
Letter; letter from Gavin Clarkson dated September 22, 2019 (``G.
Clarkson Letter''); and NAFOA Letter.
\29\ See, e.g., CMTA Letter.
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After considering these comments and recommendations, we are
proposing to amend the accredited investor definition in Rule 501(a) of
Regulation D by modifying a number of the definition's existing
categories and by adding new categories to the definition.\30\
Specifically, we are proposing to:
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\30\ We are also proposing conforming amendments to the
accredited investor definition in Rule 215 under the Securities Act.
The Rule 215 and Rule 501(a) definitions of accredited investor
historically have been substantially consistent but not identical.
See discussion in Section II.E.
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Add new categories to the definition that would permit
natural persons to qualify as accredited investors based on certain
professional certifications or designations or credentials from an
accredited educational institution or, with respect to investments in a
private fund, based on the person's status as a ``knowledgeable
employee'' of the fund; \31\
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\31\ A private fund is an issuer that would be an investment
company, as defined in Section 3 of the Investment Company Act, but
for Sections 3(c)(1) or 3(c)(7) of that Act. See Section 202(a)(29)
of the Advisers Act.
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Add certain entity types to the current list of entities
that may qualify as accredited investors, as well as add a new category
for any entity owning ``investments,'' as defined in 17 CFR 270.2a51-
1(b) under the Investment Company Act (``Rule 2a51-1(b)''), 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 Advisers Act;
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; and
Codify certain staff interpretive positions that relate to
the accredited investor definition.\32\
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\32\ See infra Sections II.B.3, II.C.3, and II.C.5.
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In addition, we are proposing to amend the definition of
``qualified institutional buyer'' in Rule 144A(a)(1) \33\ to include
additional entity types that meet the $100 million threshold to avoid
inconsistencies between the types of entities that are eligible for
accredited investor status and those that are eligible for qualified
institutional buyer status under Rule 144A.
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\33\ 17 CFR 230.144A(a)(1).
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The amendments we propose today are the product of many years of
efforts by the Commission and its staff to consider and analyze
possible approaches to revising the accredited investor definition. A
number of the proposed amendments are consistent with those recommended
by the Commission staff in the 2015 Staff Report, while some of the
proposed amendments are substantially similar to those the Commission
proposed in 2007.\34\ Many of the proposed amendments have been
recommended in the past, in one form or another, by the Advisory
Committee on Small and Emerging Companies, the Investor Advisory
Committee, and a wide array of public commenters.
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\34\ Revisions of Limited Offering Exemptions in Regulation D,
Release No. 33-8828 (Aug. 3, 2007) [72 FR 45116 (Aug. 10, 2007)]
(``2007 Proposing Release'').
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Unregistered offerings conducted under Regulation D, particularly
those under Rule 506(b), play a significant role in capital formation
in the United States. In 2018, the estimated amount of capital
(including both equity and debt) reported as being raised in Rule 506
offerings was $1.7 trillion,\35\ compared to $1.4 trillion raised in
registered offerings.\36\ Of the $1.7 trillion, $1.5
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trillion was raised by pooled investment funds, and $228 billion was
raised by non-fund issuers. As noted in the 2015 Staff Report, and as
discussed further in Section VII below, accredited investors are
critical to providing capital for the Regulation D market. There may be
investment opportunities, particularly with respect to early stage and
high growth firms, in the Regulation D market that are not available to
investors in registered securities offerings.\37\ At the same time,
investors in the Regulation D market can be subject to investment risks
not associated with registered offerings because, for example, issuers
in this market generally are not required to provide information
comparable to that included in a registration statement.
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\35\ See Concept Release at 30466.
\36\ See Concept Release at 30465. Unless otherwise indicated,
information in this release on Regulation D offerings is based on
analysis by staff in the Commission's Division of Economic and Risk
Analysis (``DERA'') of data collected from Form D filings on the
Commission's Electronic Data Gathering, Analysis, and Retrieval
system (``EDGAR'') from January 2009 through December 2018. DERA
staff determined the amount raised based on the amounts reported as
``Total amount sold'' in all Form D filings (new filings and
amendments) on EDGAR. Subsequent amendments to a new filing were
treated as incremental fundraising and recorded in the calendar year
in which the amendment was filed. It is likely that the reported
data on Regulation D offerings underestimates the actual amount
raised through these offerings for two reasons. First, 17 CFR
230.503 (``Rule 503'') of Regulation D requires issuers to file a
Form D no later than 15 days after the first sale of securities, but
a failure to file the notice does not invalidate the exemption.
Accordingly, despite the filing requirement, it is possible that
some issuers do not file Forms D for offerings relying on Regulation
D. Second, underreporting could also occur because a Form D may be
filed prior to completion of the offering, and our rules do not
require issuers to amend a Form D to report the total amount sold on
completion of the offering or to reflect additional amounts offered
if the aggregate offering amount does not exceed the original
offering size by more than 10%.
\37\ For example, according to Ritter (2019), the median age of
a firm that went public in 1999 was 5 years, while in 2018 the
median age was 10 years, see https://site.warrington.ufl.edu/ritter/files/2019/03/IPOs2018Age.pdf.
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Accordingly, in proposing changes to the definition, and in
particular changes in the types of natural persons that would qualify
as an ``accredited investor'' under these amendments, we have
considered investor protection concerns, including concerns about an
investor's ability to participate in and supply capital to the
Regulation D market. As discussed below, the accredited investor
definition is a central component of Regulation D. We are mindful that
an overly broad definition could potentially undermine important
investor protections and reduce public confidence in this vital market.
At the same time, an unnecessarily narrow definition could limit
investor access to investment opportunities where there may be adequate
investor protection given factors such as that investor's financial
sophistication, net worth, knowledge and experience in financial
matters, or amount of assets under management.\38\ The amendments to
the accredited investor definition we propose in this release reflect a
balancing of these considerations and, along with the Commission's
periodic reviews of the definition pursuant to the Dodd-Frank Act,\39\
are part of an ongoing effort to update and enhance this definition.
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\38\ See 15 U.S.C. 77b(a)(15)(i) and (ii) (establishing several
categories of accredited investors and authorizing the Commission to
adopt additional categories based on ``such factors as financial
sophistication, net worth, knowledge, and experience in financial
matters, or amount of assets under management'').
\39\ See supra note 9.
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We welcome feedback and encourage interested parties to submit
comments on any or all aspects of the proposed amendments. When
commenting, it would be most helpful if you include the reasoning
behind your position or recommendation.
II. Proposed Amendments to the Accredited Investor Definition
A. Background
The current exemptions from Securities Act registration include a
variety of requirements, investor protections, and other conditions,
including, in many cases, restrictions on the types of investors that
are permitted to participate in the offering. SEC v. Ralston
Purina,\40\ the leading case interpreting the Section 4(a)(2)
exemption, addressed the characteristics of the investors involved in
an offering exempt from registration.\41\ That decision set forth the
position that the availability of the Section 4(a)(2) exemption should
turn on whether the particular class of persons affected needs the
protection of the Securities Act. The Commission has over the years
adopted rules to provide greater certainty about exempt offerings that
are consistent with the basic criteria set forth in Ralston Purina. For
example, Rule 146--a predecessor to Regulation D adopted in 1974--
permitted offers and sales only to persons the issuer reasonably
believed had the requisite knowledge and experience in financial
matters to evaluate the risks and merits of the prospective investment
or who could bear the economic risks of the investment.\42\ Later, Rule
242 introduced the accredited investor concept into the federal
securities laws, providing a limited offering exemption up to $2
million with various conditions and defining an ``accredited person''
as a person purchasing $100,000 or more of the issuer's securities, a
director or executive officer of the issuer, or a specified type of
entity.\43\
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\40\ 346 U.S. 119, 125 (1953).
\41\ Section 4(a)(2) [15 U.S.C. 77(d)(a)(2)] exempts
transactions by an issuer ``not involving any public offering'' from
the Securities Act's registration requirements.
\42\ See Transactions By an Issuer Deemed Not To Involve Any
Public Offering, Release No. 33-5487 (Apr. 23, 1974) [39 FR 15261
(May 2, 1974)]. If all the conditions of Rule 146 were met, the
offer and sale of securities were deemed to not involve any public
offering within the meaning of Section 4(a)(2). The Commission
rescinded Rule 146 in 1982 in connection with the adoption of
Regulation D.
\43\ See Exemption of Limited Offers and Sales by Qualified
Issuers, Release No. 33-6180 (Jan. 17, 1980) [45 FR 6362 (Jan. 28,
1980)] (``Rule 242 Adopting Release''). The Commission rescinded
Rule 242 in 1982 in connection with the adoption of Regulation D.
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Congress subsequently enacted the Small Business Investment
Incentive Act of 1980,\44\ which exempted from Securities Act
registration non-public offers and sales of securities up to $5 million
made solely to accredited investors \45\ and added the accredited
investor definition to Section 2(a)(15) of the Securities Act. Section
2(a)(15)(i) defines accredited investor to mean certain enumerated
entities, and Section 2(a)(15)(ii) authorizes the Commission to adopt
additional categories based on ``such factors as financial
sophistication, net worth, knowledge, and experience in financial
matters, or amount of assets under management.'' The Commission has
used this authority to expand the types of persons that qualify as
accredited investors, as described below.
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\44\ Public Law 96-477, 94 Stat. 2275 (1980).
\45\ Securities Act Section 4(a)(5) [15 U.S.C. 77(d)(a)(5)].
---------------------------------------------------------------------------
Historically, the Commission has stated that the accredited
investor definition is ``intended to encompass those persons whose
financial sophistication and ability to sustain the risk of loss of
investment or fend for themselves render the protections of the
Securities Act's registration process unnecessary.'' \46\ The
characteristics of an investor encompassed within this standard can be
demonstrated in a variety of ways. These include the ability to assess
an investment opportunity--which includes the ability to analyze the
risks and rewards, the capacity to allocate investments in such a way
as to mitigate or avoid risks of unsustainable loss, or the ability to
gain access to information about an issuer or about an investment
opportunity--or the ability to bear the risk of a loss.\47\
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\46\ Regulation D Revisions; Exemption for Certain Employee
Benefit Plans, Release No. 33-6683 (Jan. 16, 1987) [52 FR 3015 (Jan.
30, 1987)]. See also SEC v. Ralston Purina Co., 346 U.S. 119, 125
(1953) (taking the position that the availability of the Section
4(a)(2) exemption ``should turn on whether the particular class of
persons affected needs the protection of the Act. An offering to
those who are shown to be able to fend for themselves is a
transaction `not involving any public offering.' '').
\47\ The accredited investor standard is similar to, but
distinct from, other regulatory standards in Commission rules that
are used to identify persons who are not in need of certain investor
protection features of the federal securities laws. For example,
Section 3(c)(7) of the Investment Company Act excepts from the
definition of investment company any issuer, the outstanding
securities of which are owned exclusively by persons who, at the
time of acquisition of such securities, are qualified purchasers,
and which is not making and does not at that time propose to make a
public offering of securities. Congress defined qualified purchasers
as: (i) Natural persons who own not less than $5 million in
investments; (ii) family-owned companies that own not less than $5
million in investments; (iii) certain trusts; and (iv) persons,
acting for their own accounts or the accounts of other qualified
purchasers, who in the aggregate own and invest on a discretionary
basis, not less than $25 million in investments (e.g., institutional
investors). These other regulatory standards each serve a different
regulatory purpose. Accordingly, an accredited investor will not
necessarily meet these other standards and these other regulatory
standards are not designed to capture the same investor
characteristics as the accredited investor standard. See also 2015
Staff Report, supra note 4, at section III.
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[[Page 2578]]
Regulation D, adopted in 1982,\48\ is a series of rules that sets
forth exemptions and a safe harbor from the registration requirements
of the Securities Act.\49\ Rule 506(b) of Regulation D is a non-
exclusive safe harbor under Section 4(a)(2) of the Securities Act
pursuant to which an issuer may offer and sell an unlimited amount of
securities, provided that offers are made without the use of general
solicitation or general advertising and sales are made only to
accredited investors and up to 35 non-accredited investors who meet an
investment sophistication standard.\50\ Rule 506(c) of Regulation D
provides an exemption without any limitation on offering amount
pursuant to which offers may be made through general solicitation or
general advertising, so long as the purchasers in the offering are
limited to accredited investors and the issuer takes reasonable steps
to verify their accredited investor status.\51\ The accredited investor
definition, which is found in Rule 501(a), is a cornerstone of
Regulation D. It also plays an important role in other federal and
state securities law contexts.\52\
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\48\ Revision of Certain Exemptions From Registration for
Transactions Involving Limited Offers and Sales, Release No. 33-6389
(Mar. 8, 1982) [47 FR 11251 (Mar. 16, 1982)] (``Regulation D 1982
Adopting Release'').
\49\ Rules 500 through 503 of Regulation D contain the notes,
definitions, terms, and conditions that apply generally throughout
Regulation D. The exemptions and safe harbor of Regulation D are set
forth in Rule 504, Rule 506(b), and Rule 506(c). Rule 507 of
Regulation D is a provision that disqualifies issuers under certain
circumstances from relying on Regulation D for failure to file a
notice of sales on Form D. Rule 508 of Regulation D provides that
certain insignificant deviations from a term, condition, or
requirement of Regulation D will not necessarily result in the loss
of a Regulation D exemption.
\50\ See 17 CFR 230.506(b)(2)(ii) (``Each purchaser who is not
an accredited investor either alone or with his purchaser
representative(s) has such knowledge and experience in financial and
business matters that he is capable of evaluating the merits and
risks of the prospective investment, or the issuer reasonably
believes immediately prior to making any sale that such purchaser
comes within this description.'').
\51\ 17 CFR 230.506(c). The Commission adopted Rule 506(c) in
2013 to implement Section 201(a) of the Jumpstart Our Business
Startups Act (``JOBS Act''). Public Law No. 112-106, 126 Stat. 306
(2012). See Eliminating the Prohibition Against General Solicitation
and General Advertising in Rule 506 and Rule 144A Offerings, Release
No. 33-9415 (Jul. 10, 2013) [78 FR 44771 (Jul. 24, 2013)].
\52\ See Section V for a discussion of certain implications of
the accredited investor definition under federal and state
securities laws.
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The current accredited investor definition provides that natural
persons and entities that come within, or that the issuer reasonably
believes comes within, any of eight enumerated categories at the time
of the sale of the securities is an accredited investor. Natural
persons may qualify as accredited investors based on the following
criteria:
Individuals who have a net worth exceeding $1 million
(excluding the value of the individual's primary residence), either
alone or with their spouses; \53\
---------------------------------------------------------------------------
\53\ Rule 501(a)(5).
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Individuals who had an income in excess of $200,000 in
each of the two most recent years, or joint income with the
individual's spouse in excess of $300,000 in each of those years, and
have a reasonable expectation of reaching the same income level in the
current year; \54\ and
---------------------------------------------------------------------------
\54\ Rule 501(a)(6).
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Directors, executive officers, and general partners of the
issuer or of a general partner of the issuer.\55\
---------------------------------------------------------------------------
\55\ Rule 501(a)(4).
Some entities may qualify as accredited investors based on their status
alone. These entities include:
Banks, savings and loan associations, brokers or dealers
registered pursuant to Section 15 of the Exchange Act, insurance
companies, small business investment companies, investment companies
registered under the Investment Company Act, or business development
companies as defined in Section 2(a)(48) of that Act; \56\
---------------------------------------------------------------------------
\56\ Rule 501(a)(1).
---------------------------------------------------------------------------
Private business development companies as defined in
Section 202(a)(22) of the Advisers Act; \57\ and
---------------------------------------------------------------------------
\57\ Rule 501(a)(2).
Entities in which all of the equity owners are accredited
investors.\58\
---------------------------------------------------------------------------
\58\ Rule 501(a)(8).
Other entities may qualify as accredited investors based on a
combination of their status and the amount of their total assets. These
---------------------------------------------------------------------------
entities include:
Tax exempt charitable organizations, corporations,
Massachusetts or similar business trusts, or partnerships, not formed
for the specific purpose of acquiring the securities offered, with
total assets in excess of $5 million; \59\
---------------------------------------------------------------------------
\59\ Rule 501(a)(3).
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Plans established and maintained by a state, its political
subdivisions, or any agency or instrumentality of a state or its
political subdivisions, for the benefit of its employees, if such plan
has total assets in excess of $5 million; \60\
---------------------------------------------------------------------------
\60\ Rule 501(a)(1).
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Employee benefit plans (within the meaning of the Employee
Retirement Income Security Act) if a bank, savings and loan
association, insurance company, or registered investment adviser makes
the investment decisions, or if the plan has total assets in excess of
$5 million; \61\ and
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\61\ Rule 501(a)(1).
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Trusts with total assets in excess of $5 million, not
formed for the specific purpose of acquiring the securities offered,
the purchases of which are directed by a person who meets the legal
standard of having sufficient knowledge and experience in financial and
business matters to be capable of evaluating the merits and risks of
the prospective investment.\62\
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\62\ Rule 501(a)(7).
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The Commission has amended the accredited investor definition on
three occasions since the adoption of Regulation D in 1982.\63\ First,
in 1988, the Commission expanded the definition to include additional
types of entities,\64\ added a joint income test for natural persons,
and eliminated a standard under which a person could qualify as an
accredited investor based on the purchase of $150,000 of the securities
being offered when the purchase price did not exceed 20% of the
person's net worth.\65\ Second, in 1989, the Commission amended the
definition to include plans established and maintained by state
governments and their political subdivisions, as well as their agencies
and instrumentalities, for the benefit of their employees if the plans
have total assets in excess of $5
[[Page 2579]]
million.\66\ Third, in 2011, to implement the requirements of Section
413(a) of the Dodd-Frank Act, the Commission amended the $1 million net
worth standard for natural persons to exclude the value of the
investor's primary residence.\67\
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\63\ In addition, in 2007, the Commission proposed but did not
adopt a number of changes to the accredited investor definition,
which would have, among other things, added an alternative
``investments-owned'' standard, established a mechanism to adjust
the dollar-amount thresholds to reflect inflation, and added several
categories of permitted entities to the list of accredited
investors. See 2007 Proposing Release. In 2013, the Commission
requested comment on the accredited investor definition in
connection with proposed amendments to Regulation D and Form D.
Amendments to Regulation D, Form D and Rule 156, Release No. 33-9416
(July 10, 2013) [78 FR 44806 (July 24, 2013)].
\64\ The types of institutional investors added were savings and
loan associations and other institutions specified in Section
3(a)(5)(A) of the Securities Act (including credit unions), broker-
dealers, certain trusts, partnerships, and corporations.
\65\ Regulation D Revisions, Release No. 33-6758 (Mar. 3, 1988)
[53 FR 7866 (Mar. 10, 1988)] (``Regulation D 1988 Adopting
Release'').
\66\ Regulation D, Release No. 33-6825 (Mar. 15, 1989) [54 FR
11369 (Mar. 20, 1989)] (``Regulation D 1989 Adopting Release'').
\67\ Net Worth Standard for Accredited Investors, Release No.
33-9287 (Dec. 21, 2011) [76 FR .81793 (Dec. 29, 2011)] (``Regulation
D 2011 Adopting Release'').
---------------------------------------------------------------------------
Although the current accredited investor definition uses wealth--in
the form of a certain level of income, net worth, or assets--as a proxy
for financial sophistication, we do not believe wealth should be the
sole means of establishing financial sophistication for purposes of the
accredited investor definition. Accordingly, the proposed amendments
would create new categories of individuals and entities that would
qualify as accredited investors irrespective of their wealth, on the
basis that such investors have the requisite ability to assess an
investment opportunity. We discuss these and other proposed amendments
to the accredited investor definition in detail below.
B. Adding Categories of Natural Persons Who Qualify as Accredited
Investors
We are proposing to add two new categories in the accredited
investor definition for natural persons (1) who hold certain
professional certifications or designations or other credentials, or
(2) who are ``knowledgeable employees'' of a private fund and are
investing in the private fund. With the exception of directors,
executive officers, and general partners of the issuer, the current
accredited investor definition uses only the financial measures of
income and net worth as proxies for a natural person's financial
sophistication. The proposed new categories would apply additional
markers of financial sophistication for natural persons based on
professional knowledge and experience.
1. Professional Certifications and Designations and Other Credentials
We propose to add a category for natural persons to qualify as
accredited investors based on certain professional certifications and
designations or other credentials that demonstrate an individual's
background and understanding in the areas of securities and
investing.\68\ We believe that this approach would provide appropriate
alternative means of assessing an investor's need for the protections
of registration under the Securities Act. We recognize that investors
holding such certifications, designations and credentials may not meet
the current financial thresholds in the accredited investor definition,
and therefore the impact of investment losses on such investors could
be significant. Nevertheless, we believe that the concept of financial
sophistication encompasses not only an ability to analyze the risks and
rewards of an investment but also the capacity to allocate investments
in a way to mitigate or avoid risks of unsustainable loss. Adding this
new category of individual accredited investors may potentially expand
the pool of investors eligible to participate in, and provide capital
to, the Regulation D market. As discussed below, we also believe that
this standard in some cases could reduce compliance burdens for issuers
by providing an alternative basis for qualification that issuers may be
able to assess more easily than the current net worth or annual income
standards.
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\68\ This proposal is limited to natural persons seeking to
qualify as accredited investors on their own behalf, and any
discussion in the release of professional certifications,
designations, and other credentials has no applicability in the
context of that individual making investment recommendations to
others as a financial professional.
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The 2015 Staff Report included a staff recommendation that the
Commission permit individuals with certain professional credentials to
qualify as accredited investors. Commenters who expressed a view about
this recommendation generally supported the recommendation.\69\ Several
commenters stated that qualifying credentials should include one or
more of the following: Passing the Series 7, Series 65, Series 66, or
Series 82 examinations, being a certified public accountant (CPA),
certified financial analyst (CFA), certified management accountant
(CMA), investment adviser representative or registered representative
(RR); having a Masters of Business Administration degree (MBA) from an
accredited educational institution or having a certified investment
management analyst (CIMA) certification; or having been in the
securities industry as a broker, lawyer, or accountant.\70\ Other
commenters expressed more general views about the sophistication
necessary to qualify as an accredited investor.\71\
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\69\ See, e.g., letter from Consumer Federation of America and
Americans for Financial Reform dated April 27, 2016 (``CFA/AFR
Letter''); letter from Dar'shun Kendrick, Kendrick Law Practice
dated May 1, 2016 (``D. Kendrick Letter''); letter from National
Small Business Association dated March 29, 2016 (``NSBA Letter'');
letter from North American Securities Administrators Association
(``NASAA'') dated May 25, 2016 (``2016 NASAA Letter''); letter from
Kyle Beagle dated January 13, 2016 (``K. Beagle Letter''); letter
from Ava Badiee dated May 10, 2016; letter from Chase R. Morello
dated January 13, 2016; letter from Keith J. Johnson dated Mar. 6,
2016; letter from Cornell Securities Law Clinic dated April 30, 2016
(``Cornell Law Clinic Letter''); letter from Investment Management
Consultants Association dated March 29, 2016 (``IMCA Letter'');
letter from Anonymous Investment Banker dated April 13, 2016; letter
from Leonard A. Grover, dated June 13, 2016 (``2016 L. Grover
Letter''); letter from The TAN2000 International Regulatory
Corporation dated December 10, 2016 (``TAN2000 Letter''); letter
from Jeff Carlsen dated January 17, 2017 (``J. Carlsen Letter'');
letter from Managed Funds Association dated June 16, 2016 (``MFA-1
Letter''); letter from Managed Funds Association dated May 18, 2017
(``MFA-2 Letter''); letter from Mark R. Maisonneuve dated April 26,
2017 (``M. Maisonneuve Letter''); and letter from Crowdfund
Intermediary Regulatory Advocates dated January 14, 2016 (``CFIRA
Letter''). Some of these commenters supported the recommendation
with additional limitations and conditions such as a minimum amount
of professional experience or investment limits. See, e.g., Beagle
Letter; D. Kendrick Letter; Cornell Law Clinic Letter; 2016 NASAA
Letter; and TAN2000 Letter.
\70\ See, e.g., CFA/AFR Letter (``. . . the Series 7, Series 65,
and Series 82 examinations likely `provide demonstrable evidence of
relevant investor sophistication because of the subject matter their
examinations cover' ''); 2016 NASAA Letter (recommending qualifying
credentials to include passing the Series 7, Series 65, or Series
66, provided that there is also a requisite minimum amount of
professional experience); MFA-1 Letter and MFA-2 Letter
(recommending qualifying credentials would include being a CPA or
CFA or having a MBA from an accredited educational institution); M.
Maisonneuve Letter (recommending qualifying credentials would
include being a CFA); IMCA Letter (recommending qualifying
credentials would include having a CIMA certification); CFIRA Letter
(recommending qualifying credentials would include being a CPA, CFA,
CMA, registered investment adviser, RR or securities attorney); and
D. Kendrick Letter (recommending qualifying credentials would
include having been in the securities industry as a broker, lawyer,
or accountant).
\71\ See, e.g., NSBA Letter (``. . . if someone is sophisticated
enough to advise others on investing in these types of offerings,
for example, they should themselves be qualified to invest in
them''); Cornell Law Clinic Letter (credentials required should be
substantially high to cause financial sophistication to make up for
the loss in ability to sustain financial losses); 2016 L. Grover
Letter (experts in industries historically passed over by angel
investors should be allowed to qualify as accredited investors); and
J. Carlsen Letter (individuals with business-related college
degrees).
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[[Page 2580]]
Several recent advisory committee recommendations similarly have
supported expanding the criteria for natural persons to qualify as
accredited investors. In 2014, the Investor Advisory Committee
recommended that the Commission revise the accredited investor
definition to enable individuals to qualify as accredited investors
based on their ``financial sophistication.'' \72\ In 2015, the Advisory
Committee on Small and Emerging Companies recommended including in the
accredited investor definition those investors who meet a
``sophistication test,'' regardless of income or net worth.\73\ In
2016, the Advisory Committee on Small and Emerging Companies
recommended, among other things, that the Commission expand the pool of
accredited investors to include individuals who have passed
examinations that test their knowledge and understanding in the areas
of securities and investing, including the Series 7, Series 65, Series
82, and CFA Examinations and equivalent examinations.\74\ In October
2017, the U.S. Department of the Treasury issued a report that includes
recommendations on amending the accredited investor definition with the
objective of expanding the eligible pool of sophisticated investors to
financial professionals, such as registered representatives and
investment adviser representatives, who generally are considered
qualified to recommend Regulation D investments to others.\75\ In
addition, the 2016, 2017, and 2018 Small Business Forum Reports
included a recommendation that the Commission expand the categories of
qualification for accredited investor status based on various types of
sophistication, such as education, experience, or training, including,
among other things, persons holding FINRA licenses or CPA or CFA
designations. The 2019 Small Business Forum Report included a
recommendation that the Commission revise the accredited investor
definition for natural persons to add a sophistication test as a way to
qualify in addition to the income and net worth thresholds in the
definition.\76\
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\72\ 2014 Investor Advisory Committee Recommendation.
\73\ 2015 ACSEC Recommendations.
\74\ 2016 ACSEC Recommendations.
\75\ A Financial System That Creates Economic Opportunities
Capital Markets, U.S. Dept. of the Treasury (Oct. 2017) (``2017
Treasury Report''), available at https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINALpdf, at p. 44. Some registered representatives may hold
limited licenses that preclude them from recommending Regulation D
investments to others.
\76\ See the 2019 Small Business Forum Report at 8.
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The Concept Release requested comment on the use of additional
sophistication measures other than income or net worth to permit
natural persons to qualify as accredited investors. Table 1 below
provides an overview of the feedback provided by Concept Release
commenters on this topic.
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\77\ See K. Sonlin Letter; AOIP Letter; letter from Jor Law
Dated July 10, 2019 (``J. Law Letter''); letter from Leonard A.
Grover dated July 10, 2019 (``2019 L. Grover Letter''); letter from
Broadmark Capital LLC dated July 29, 2019 (``Broadmark Capital
Letter''); C. Uchill Letter; letter from Steven Marshall dated
August 18, 2019 (``S. Marshall Letter''); J. LaBerge Letter; IWI
Letter; Wefunder Letter; HFA Letter; ACA Letter; Funding Circle
Letter; letter from Joe Wallin et al. dated September 23, 2019 (``J.
Wallin Letter''); letter from G. Philip Rutledge dated September 24,
2019 (``P. Rutledge Letter''); letter from SeedInvest dated
September 24, 2019 (``SeedInvest Letter''); letter from Republic
dated September 24, 2019 (``Republic Letter''); CFA Institute
Letter; EquityZen Letter; Iownit Letter; letter from David R. Burton
dated September 24, 2019 (``D. Burton Letter''); CoinList Letter;
2019 SBIA Letter; letter from AngelList Advisors, LLC dated
September 25, 2019 (``AngelList Letter''); letter from William F.
Galvin, Secretary of the Commonwealth of Massachusetts dated
September 24, 2019 (``MA Secretary Letter''); Davis Polk Letter;
letter from Crystal World Holdings and New Sports Economy Institute
dated September 24, 2019 (``CWH and NSEI Letter''); H. Konings et
al. Letter; letter from Crowdfund Capital Advisors dated September
24, 2019 (``CCA Letter''); SIFMA Letter; CCMC Letter; ACG Letter;
IPA Letter; ADISA Letter; letter from Carta dated September 24, 2019
(``Carta Letter''); McCarter & English Letter; letter from Jade
Barker dated September 24, 2019 (``J. Barker Letter''); J. Schocken
Letter; Artivest Letter; J. Tapp Letter; letter from Cody Snyder
dated September 11, 2019 (``C. Snyder Letter''); Bridgeport Letter;
MLA Letter; J. Thomas Letter; letter from Kirk McGregor and Samarth
Sandeep dated September 24, 2019 (``McGregor and Sandeep Letter'');
CfPA Letter; A. Ceja Letter; ABA FR of Sec. Comm. Letter; Sec. Reg.
Comm. of N.Y.St. B.A. Letter; letter from Leyline Corporation dated
October 18, 2019 (``Leyline Letter''); letter from Joey Jones dated
October 29, 2019 (``J. Jones Letter''); letter from CrowdCheck dated
October 30, 2019 (``CrowdCheck Letter''); and Recommendation of the
SEC Small Business Capital Formation Advisory Committee regarding
the accredited investor definition (Dec. 11, 2019), (the ``2019
Advisory Committee Recommendation''), available at https://www.sec.gov/spotlight/sbcfac/recommendation-accredited-investor.pdf..
\78\ See 2019 L. Grover Letter; C. Uchill Letter; Wefunder
Letter; ACA Letter; P. Rutledge Letter; SeedInvest Letter; Republic
Letter; EquityZen Letter; D. Burton Letter; CoinList Letter; Davis
Polk Letter; H. Konings et al. Letter; ACG Letter; IPA Letter; ADISA
Letter; McCarter & English Letter; Artivest Letter; CfPA Letter;
Sec. Reg. Comm. of N.Y.St. B.A. Letter; Leyline Letter; J. Jones
Letter; and CrowdCheck Letter.
\79\ See J. Law Letter; SeedInvest Letter; Republic Letter;
EquityZen Letter; D. Burton Letter; CoinList Letter; Davis Polk
Letter; CWH and NSEI Letter; SIFMA Letter; ACG Letter; IPA Letter;
Artivest Letter; CfPA Letter; and CrowdCheck Letter.
\80\ See D. Burton Letter and CoinList Letter.
\81\ See J. Tapp Letter; J. Law Letter; 2019 L. Grover Letter;
C. Uchill Letter; C. Snyder Letter; IWI Letter; Bridgeport Letter;
HFA Letter; ACA Letter; Funding Circle Letter; MLA Letter; J. Wallin
Letter; P. Rutledge Letter; SeedInvest Letter; Republic Letter; D.
Burton Letter; 2019 SBIA Letter; CWH and NSEI Letter; CCMC Letter;
ACG Letter; J. Thomas Letter; Carta Letter; McGregor and Sandeep
Letter; CfPA Letter; ABA FR of Sec. Comm. Letter; J. Jones Letter;
CrowdCheck Letter; and the 2019 Advisory Committee Recommendation.
\82\ See Consumer Federation Letter.
\83\ See K. Sonlin Letter; Broadmark Capital Letter; C. Uchill
Letter; S. Marshall Letter; J. LaBerge Letter; Wefunder Letter; HFA
Letter; ACA Letter; SeedInvest Letter; Republic Letter; EquityZen
Letter; D. Burton Letter; CoinList Letter; CWH and NSEI Letter; H.
Konings et al. Letter; CCA Letter; SIFMA Letter; CCMC Letter; IPA
Letter; ADISA Letter; McCarter & English Letter; J. Barker Letter;
Artivest Letter; CfPA Letter; A. Ceja Letter; ABA FR of Sec. Comm.
Letter; and the 2019 Advisory Committee Recommendation.
\84\ See, e.g., Consumer Federation Letter and PIABA Letter.
Table 1--Responses to Requests for Comment on Additional Sophistication
Tests in the Accredited Investor Definition
------------------------------------------------------------------------
Responses from commenters
-------------------------------------------------------------------------
--Many commenters supported adding a sophistication-based category to
the accredited investor definition.\77\ Of those commenters:
--Several commenters supported a sophistication category based on
passing certain FINRA-administered examinations.\78\
--Several commenters supported a sophistication category based on
obtaining a Chartered Financial Analyst certification.\79\
--Two commenters supported a sophistication category based on
obtaining a Certified Financial Planner certification.\80\
--Several commenters supported the use of an accredited investor
examination.\81\
--One commenter believed insufficient demand existed for an
accredited investor examination.\82\
--Several commenters supported the use of educational experience
more generally.\83\
--A few other commenters expressed concern about adding
sophistication-based categories to the definition.\84\
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[[Page 2581]]
Having considered this feedback, we believe that certain
professional certifications and designations or other credentials can
indicate an appropriate level of financial sophistication that renders
these investors less in need of the protections of registration under
the Securities Act. Indeed, relying solely upon financial thresholds
may unduly restrict access to investment opportunities for individuals
whose knowledge and experience render them capable of evaluating the
merits and risks of a prospective investment--and therefore fending for
themselves--in a private offering, irrespective of their personal
wealth. Accordingly, and consistent with suggestions from a broad range
of commenters, we are proposing to amend the rule to include natural
persons holding one or more professional certifications or designations
or other credentials issued by an accredited educational institution
that the Commission designates from time to time as meeting specified
criteria. In addition, where applicable, an investor would need to
maintain these certifications, designations, or credentials in good
standing in order to qualify for accredited investor status.
The Commission's designation of certifications, designations, or
credentials would be based upon its consideration of all the facts
pertaining to a particular certification, designation, or credential.
The proposed amendment would provide the following non-exclusive list
of attributes that the Commission would consider in determining which
professional certifications and designations or other credentials
qualify for accredited investor status:
The certification, designation, or credential arises out
of an examination or series of examinations administered by a self-
regulatory organization or other industry body or is issued by an
accredited educational institution;
The examination or series of examinations is designed to
reliably and validly demonstrate an individual's comprehension and
sophistication in the areas of securities and investing;
Persons obtaining such certification, designation, or
credential can reasonably be expected to have sufficient knowledge and
experience in financial and business matters to evaluate the merits and
risks of a prospective investment; and
An indication that an individual holds the certification
or designation is made publicly available by the relevant self-
regulatory organization or other industry body.
Professional certifications and designations or other credentials
meeting these proposed criteria would be designated as qualifying for
accredited investor status by means of a Commission order. We
anticipate that the Commission generally would provide public notice
and an opportunity for public comment before issuance of such an order.
To assist members of the public, the professional certifications and
designations or other credentials recognized by the Commission as
satisfying the above criteria would be posted on the Commission's
website.
We recognize that professional certifications and designations or
credentials may evolve with changes in the market and industry
practices. The proposed approach would provide the Commission with
flexibility to reevaluate previously designated certifications,
designations, or credentials if they change over time, and also to
designate other certifications, designations, or credentials if new
certifications, designations or credentials develop that meet the
specified criteria.
We preliminarily expect that the following certifications or
designations would be included in an initial Commission order
accompanying the final rule, if adopted:
Licensed General Securities Representative (Series 7). The
Series 7 license qualifies a candidate ``for the solicitation,
purchase, and/or sale of all securities products, including corporate
securities, municipal securities, municipal fund securities, options,
direct participation programs, investment company products, and
variable contracts.'' \85\ FINRA developed and administers the Series 7
examination. An individual must be associated with a FINRA member firm
or other applicable self-regulatory organization member firm to be
eligible to take the exam and be granted a license.\86\
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\85\ https://www.finra.org/registration-exams-ce/qualification-exams/series7.
\86\ FINRA Rule 1210.03. Candidates must also pass the
Securities Industry Essentials (SIE) examination to obtain the
General Securities Representative designation.
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Licensed Investment Adviser Representative (Series 65).
The Series 65 Uniform Investment Adviser Law Examination is designed to
qualify candidates as investment adviser representatives and covers
topics necessary for adviser representatives to understand to provide
investment advice to retail advisory clients.\87\ NASAA developed the
Series 65 examination, and FINRA administers it. An individual does not
need to be sponsored by a member firm to take the exam, and successful
completion of the exam does not convey the right to transact business
prior to being granted a license or registration by a state.\88\
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\87\ https://www.nasaa.org/exams/study-guides/series-65-study-guide/.
\88\ https://www.nasaa.org/exams/exam-faqs/.
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Licensed Private Securities Offerings Representative
(Series 82). The Series 82 license qualifies individuals seeking to
effect the sales of private securities offerings.\89\ The examination
focuses on private transactions and is more limited in scope than the
Series 7 examination. FINRA developed and administers the Series 82
examination. An individual must be associated with and sponsored by a
FINRA member firm or other applicable self-regulatory organization
member firm to be eligible to take the exam.\90\
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\89\ https://www.finra.org/registration-exams-ce/qualification-exams/series82. Candidates must also pass the SIE examination to
obtain the Private Securities Offerings Representative designation.
\90\ FINRA Rule 1210.03.
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The proposed amendments would enable persons holding designated
certifications, designations, or credentials to qualify as accredited
investors even when they do not meet the income or net worth standards
in the accredited investor definition. We preliminarily believe that
individuals who have passed the necessary examinations and received
their certifications or designations described above have demonstrated
a level of sophistication in the areas of securities and investing such
that they may not need the protections of registration under the
Securities Act. In this regard, we note that these certifications and
designations are required in order to represent or advise others in
connection with securities market transactions. One commenter stated
that, if an individual is ``sophisticated enough to advise others on
investing in these types of offerings . . . they should themselves be
qualified to invest in them.'' \91\
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\91\ See NSBA Letter.
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The following table sets out an estimate of the number of
individuals that may hold the certifications and designations described
above:
[[Page 2582]]
Table 2--Estimated Number of Individuals Holding Specified
Certifications and Designations
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Number of
Certification/designation individuals
------------------------------------------------------------------------
Registered Securities Representative.................. \92\ 691,041
State Registered Investment Adviser Representative.... \93\ 17,543
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As Table 2 illustrates, if we were to adopt the amendments to the
accredited investor definition as proposed and designate professional
certifications and designations as qualifying credentials, it may
result in a significant increase in the number of individuals that
qualify as accredited investors. However, we note that we cannot
estimate how many individuals that hold the relevant certifications and
designations may already qualify as accredited investors under the
current financial thresholds, and therefore we are unable to state with
certainty how many individuals would be newly eligible under the
proposals. Moreover, for purposes of updating the accredited investor
definition, we believe it is less relevant to focus on the number of
individuals that would qualify and more relevant to consider whether
the proposed criteria adequately capture the attributes of financial
sophistication that is a touchstone of the definition.
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\92\ As of December 2018. Of this number, 334,860 individuals
were registered only as broker-dealers, 294,684 were dually
registered as broker-dealers and investment advisers, and 61,497
were registered only as investment advisers.
Because FINRA-registered representatives can be required to hold
multiple professional certifications, this aggregation likely
overstates the actual number of individuals that hold a Series 7 or
Series 82, and we have no method of estimating the extent of
overlap.
\93\ As of December 2018.
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We acknowledge that there may be individuals that hold other
professional or academic credentials that can demonstrate similar
comprehension and sophistication; however, we believe that it is
appropriate at this time to tailor this category of credentials and
designations to certain ones that directly relate to securities and
investing. For example, while commenters have suggested criteria such
as college degrees and advanced degrees generally for the accredited
investor definition, we are concerned that such a broad approach might
not provide a consistent measure of financial sophistication for a
variety of reasons, including the range of degrees, the different types
of institutions that grant degrees, and the various career paths that
degree holders can take.
As proposed, where applicable, an individual would be required to
maintain an active certification, designation, or credential \94\ to
qualify as an accredited investor on this basis but would not be
required to practice in fields related to the certification,
designation, or credential, except to the extent that continued
affiliation with a firm is required to maintain the certification,
designation, or credential.\95\ We believe that passing the requisite
examinations and maintaining an active certification, designation, or
license would be sufficient to demonstrate the individual's financial
sophistication to invest in Regulation D offerings, even when the
individual is not practicing in an area related to the certification or
designation. Conversely, an inactive certification, designation, or
license, particularly when the certification or designation has been
inactive for an extended period of time, could lessen the validity of
the certification or designation as a measure of financial
sophistication.
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\94\ To maintain their certifications and designations in good
standing, General Securities Representatives and Private Securities
Offerings Representatives are subject to continuing education
requirements under FINRA rules.
\95\ For example, an individual's registration as a general
securities representative will lapse two years after the date that
his or her employment with a FINRA member has been terminated. See
FINRA Rule 1210.08.
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In addition, because issuers must take reasonable steps to verify
whether an investor in a Rule 506(c) offering is an accredited
investor,\96\ readily available information on whether an individual
actively holds a particular certification or designation would be
useful. For example, issuers and other market participants may obtain
registration and licensing information about registered representatives
and investment adviser representatives through FINRA's BrokerCheck \97\
or the Commission's Investment Adviser Public Disclosure database.\98\
For this reason, we are proposing to include, as one of the criteria to
be considered by the Commission in recognizing qualifying professional
credentials, the public availability of information listing the
individuals who hold the relevant certifications or designations.
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\96\ See supra note 51.
\97\ https://brokercheck.finra.org/.
\98\ https://www.adviserinfo.sec.gov/IAPD/Default.aspx.
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Request for Comment
1. Are professional certifications and designations or other
credentials an appropriate standard for determining whether a natural
person is an accredited investor? Do the types of certifications and
designations that the Commission is considering indicate that an
investor has the requisite level of financial sophistication and
abilities to render the protections of the Securities Act unnecessary?
2. Are the professional certifications and designations we
preliminarily expect to designate as qualifying credentials in an
initial Commission order accompanying the final rule appropriate to
recognize for this purpose? Should we include a credential from an
accredited educational institution, such as an MBA, in such initial
order?
3. Should we consider other certifications, designations, or
credentials as a means for individuals to qualify as accredited
investors? If so, which ones should we consider? For example, there are
several FINRA Representative-level and Principal-level exams, as well
as FINRA-administered NASAA exams, Municipal Securities Rulemaking Body
exams, and National Futures Association exams, that cover a broad range
of subjects relating to the markets, the securities industry and its
regulatory structure.\99\ Should we consider any other FINRA-developed
examinations or FINRA-administered examinations not discussed in this
release? Should we consider designating any professional certifications
or designations or credentials issued outside of the United States?
Should we consider other certifications and designations administered
by private organizations, such as the CFA Institute and the Certified
Financial Planner Board of Standards? Does the fact that these private
organizations are not subject to Commission oversight or regulation
raise concerns with respect to the inclusion of certifications or
designations such as the CFA Charter or the CFP Certification as a
means of accredited investor qualification?
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\99\ See https://www.finra.org/registration-exams-ce/qualification-exams.
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4. A FINRA introductory-level examination, the ``Securities
Industry
[[Page 2583]]
Essentials'' (SIE) examination, is a co-requisite to the Series 7 and
Series 82 examinations and assesses a candidate's knowledge of basic
securities industry information.\100\ The SIE examination is open to
any individual aged 18 or over, and association with a firm is not
required. Passing the SIE examination alone does not qualify an
individual for registration with a FINRA member firm or to engage in
securities business. We have not included the SIE examination among
those we expect initially to designate as qualifying credentials
because the SIE examination is relatively new and evaluates
introductory-level comprehension of the securities industry. Should we
consider the SIE examination as a means for individuals to qualify as
accredited investors? Should we consider the SIE examination, in
addition to the completion of an investing-related course at an
accredited college or university, as a means for individuals to qualify
as accredited investors?
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\100\ https://www.finra.org/registration-exams-ce/qualification-exams/securities-industry-essentials-exam.
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5. FINRA's Series 86 and 87 examinations assess the ability of an
entry-level registered representative to perform their job as a
research analyst.\101\ As with the Series 7 and Series 82 examinations,
an individual must be associated with and sponsored by a FINRA member
firm or other applicable self-regulatory organization member firm to be
eligible to take the Series 86 and 87 examinations. The SIE examination
is also co-requisite to the Series 86 and 87 examinations. Should we
consider the Series 86 and 87 examinations as a means for individuals
to qualify as accredited investors?
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\101\ https://www.finra.org/registration-exams-ce/qualification-exams/series86-87.
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6. The Series 66 NASAA Uniform Combined State Law Examination
(Series 66) is designed to qualify candidates as investment adviser
representatives and as broker-dealer representatives.\102\ NASAA
developed the Series 66 examination, and FINRA administers it. An
individual does not need to be sponsored by a member firm to take the
exam,\103\ and successful completion of the exam does not convey the
right to transact business prior to being granted a license or
registration by a state. Should we consider the Series 66 examination
and registration as an investment adviser representative as a means for
individuals to qualify as accredited investors?
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\102\ https://www.finra.org/registration-exams-ce/qualification-exams/series66.
\103\ Though the Series 66 examination has no pre-requisites, in
order to register as an investment adviser representative based on
passing the Series 66 examination, an individual must also have
passed the FINRA Series 7 examination.
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7. Several types of certifications and designations, including the
Series 7, Series 82, Series 86, and 87 licenses, require that an
individual be sponsored by a FINRA member firm to take the exam. Other
certifications and designations, including the Series 65, Series 66,
and the SIE, do not have such a requirement. With respect to
certifications and designations for which an individual does not need
to be sponsored by a member firm, should we consider imposing a waiting
period following an individual's attainment of the credential or
designation before the individual can invest in an offering as an
accredited investor? If so, would a 30-day waiting period, or some
other period of time be appropriate?
8. Should we, as proposed, designate certain certifications,
designations, or credentials as qualifying credentials by order, or
should we instead include specific certifications, designations, or
credentials in the rule itself? The proposed provision specifies
various attributes that the Commission would consider in making this
determination. Is the proposed list of attributes appropriate or are
there other criteria that we should consider in determining whether
certain professional certifications or designations or other
credentials should be recognized as qualifying for accredited investor
status? One proposed attribute that may be considered is that an
indication that an individual holds the certification or designation is
made publicly available by the relevant self-regulatory organization or
other industry body. Would such a publicly available indication be
necessary if the individual can demonstrate to the issuer that he or
she has actually obtained the certification, or designation?
9. Should the individuals who obtain the designated professional
credentials be required to maintain these certifications or
designations in good standing in order to qualify as accredited
investors, as proposed? Should they also be required to practice in the
fields related to the certifications or designations, or to have
practiced for a minimum number of years? Certain of the professional
certifications or designations we are considering require an individual
to be associated with a FINRA member firm or other applicable self-
regulatory organization member firm, or require a certain amount of
work experience in order to qualify for the certification or
designation, while others do not. Is it appropriate to recognize
professional certifications or designations that require employment at
certain firms, state registration or licensure, or a minimum amount of
work experience, as proposed? If work experience is a requirement for a
certification but not a prerequisite to taking the relevant exam,
should successful completion of the exam be sufficient to qualify for
accredited investor status, instead of requiring certification?
10. Under the proposed approach, individuals with certain
certifications, designations, or credentials would qualify as
accredited investors regardless of their net worth or income. While
having such a certification, designation, or credential may be a
measure of financial sophistication, which should encompass the
investor's capacity to allocate their investments in a way to mitigate
or avoid risks of unsustainable loss, the impact of an investment loss
on an investor that does not meet the current net worth or income
thresholds may be significant. Should we consider additional
conditions, such as investment limits, for individuals with these
certifications, designations, or credentials who do not meet the income
test or net worth test, in order to qualify as accredited investors? If
so, what types of investment limits or other conditions should we
consider?
11. Should we consider educational backgrounds more generally, such
as advanced degrees in certain areas such as law, accounting, business,
or finance, as a means for qualifying as an accredited investor? If so,
which degrees would be appropriate? Should the individual also be
required to demonstrate professional experience in such areas?
12. Should we consider professional experience in areas such as
finance and investing, apart from professional certifications and
designations, as another means for qualifying for accredited investor
status? If so, what factors should we consider in evaluating whether an
individual has the capability of evaluating the merits and risks of a
prospective investment based on his or her professional experience? For
example, should the focus be on specific types and levels of job
experience? Should we consider only professional experience related to
the securities industry? If so, would it be appropriate to include only
those actively involved in the buying and selling of securities, or
should we consider other professionals whose work experience may
demonstrate an understanding of the investment process? How should the
Commission determine the appropriate level of experience needed in
order to
[[Page 2584]]
qualify as an accredited investor under such a test?
13. Should we consider developing an accredited investor
examination as another means for determining investor sophistication?
What are the advantages and disadvantages of such an approach? What
should be considered in developing and designing such an examination?
14. Should we consider permitting individuals to self-certify that
they have the requisite financial sophistication to be an accredited
investor as another means for determining investor sophistication?
2. Knowledgeable Employees of Private Funds
We propose to add a category to the accredited investor definition
that would enable ``knowledgeable employees'' of a private fund to
qualify as accredited investors for investments in the fund.\104\
Private funds, such as hedge funds, venture capital funds, and private
equity funds, are issuers that would be an investment company, as
defined in Section 3 of the Investment Company Act, but for the
exclusion from the definition of ``investment company'' in Section
3(c)(1) or Section 3(c)(7) of the Investment Company Act.\105\ Private
funds generally rely on Section 4(a)(2) and Rule 506 to offer and sell
their interests without registration under the Securities Act.
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\104\ Rule 3c-5(a)(4) under the Investment Company Act defines a
``knowledgeable employee'' with respect to a private fund as: (i) An
executive officer, director, trustee, general partner, advisory
board member, or person serving in a similar capacity, of the
private fund or an affiliated management person (as defined in Rule
3c-5(a)(1)) of the private fund; and (ii) an employee of the private
fund or an affiliated management person of the private fund (other
than an employee performing solely clerical, secretarial or
administrative functions with regard to such company or its
investments) who, in connection with his or her regular functions or
duties, participates in the investment activities of such private
fund, other private funds, or investment companies the investment
activities of which are managed by such affiliated management person
of the private fund, provided that such employee has been performing
such functions and duties for or on behalf of the private fund or
the affiliated management person of the private fund, or
substantially similar functions or duties for or on behalf of
another company for at least 12 months.
\105\ 15 U.S.C. 80a-3(c)(1) and (c)(7).
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Section 3(c)(1) of the Investment Company Act excludes from the
definition of ``investment company'' any issuer whose outstanding
securities (other than short-term paper) are beneficially owned by not
more than 100 persons, and which is not making and does not presently
propose to make a public offering of its securities. As discussed
above, Section 3(c)(7) of the Investment Company Act excludes from the
definition of ``investment company'' any issuer whose outstanding
securities are owned exclusively by persons who, at the time of
acquisition of such securities, are ``qualified purchasers,'' and which
is not making and does not at that time propose to make a public
offering of its securities.\106\
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\106\ Issuers that rely on Section 3(c)(1) or 3(c)(7) of the
Investment Company Act are a subset of pooled investment funds. The
definition of ``qualified purchaser'' in Section 2(a)(51) of the
Investment Company Act includes any natural person (including any
person who holds a joint, community property, or other similar
shared ownership interest in an issuer that is excepted under
Section 3(c)(7) of the Investment Company Act with that person's
qualified purchaser spouse) who owns not less than $5 million in
investments (as defined by the Commission).
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Pursuant to Rule 3c-5, ``knowledgeable employees'' of a private
fund may acquire securities issued by the fund without being counted
for purposes of Section 3(c)(1)'s 100-investor limit and may invest in
a Section 3(c)(7) fund even though they do not meet the definition of
``qualified purchaser.'' \107\ This provision permits individuals who
participate in a fund's management to invest in the fund as a benefit
of employment.\108\ However, even though a knowledgeable employee is
permitted to invest in a Section 3(c)(7) fund (along with other natural
persons that have a high degree of financial sophistication),\109\ a
knowledgeable employee may not meet the financial thresholds in the
accredited investor definition. Therefore, a knowledgeable employee who
does not meet the accredited investor definition may be excluded from
participating in an offering of the private fund under Rule 506 if the
offering is limited to accredited investors.
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\107\ Rule 3c-5(b).
\108\ 2015 Staff Report.
\109\ Such an employee would be considered a qualified client
under Rule 205-3(d)(1)(iii) under the Advisers Act (allowing such
funds to offer performance fees).
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The 2015 Staff Report included a recommendation that the Commission
revise the accredited investor definition to permit knowledgeable
employees of sponsors of private funds to qualify as accredited
investors for investments in the funds sponsored by their employers,
using the definition of the term ``knowledgeable employee'' in Rule 3c-
5(a)(4). In response to the 2015 Staff Report, several commenters
expressed support for the recommendation,\110\ while one commenter
opposed this recommendation.\111\ In July 2016, the Advisory Committee
on Small and Emerging Companies, though not specifically referencing
knowledgeable employees, recommended that the Commission explore more
generally different ways to permit participation by potential investors
with specific industry or issuer knowledge or expertise who would
otherwise not qualify for accredited investor status.\112\ The 2016,
2017, and 2018 Small Business Forum Reports included a recommendation
that the Commission expand the categories of qualification to include,
among other things, status as managerial or key employees affiliated
with the issuer. In addition, a number of commenters on the Concept
Release supported permitting a private fund's knowledgeable employees
to invest in the private fund.\113\
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\110\ See, e.g., CFA/AFR Letter (``. . . such individuals
`likely have significant investing experience and sufficient access
to the information necessary to make informed decisions about
investments in their employer's funds' ''); NSBA Letter; Cornell Law
Clinic Letter (``Knowledgeable employees of private funds are likely
some of the highest levels of financial sophistication among
potential investors.''); MFA-1 Letter; and MFA-2 Letter (``. . .
such knowledgeable employees have meaningful investing experience
and sufficient access to information necessary to make informed
investment decisions about the private fund's offerings. In
addition, investments by knowledgeable employees are beneficial for
private fund investors in that they further align investor interests
of adviser employees and fund investors.'').
\111\ See 2016 NASAA Letter (``Such an approach could raise
suitability issues, may be difficult to verify, and ultimately has a
negligible impact in improving capital formation efforts.'').
\112\ See 2016 ACSEC Recommendations.
\113\ See ACA Letter; Funding Circle Letter; MLA Letter; J.
Wallin Letter; P. Rutledge Letter; MFA and AIMA Letter; EquityZen
Letter; 2019 SBIA Letter; BlackRock Letter; ACG Letter; letter from
Dechert LLP dated September 24, 2019; Artivest Letter; and Sec. Reg.
Comm. of N.Y.St. B.A. Letter.
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We are not able to estimate the number of individuals that would
qualify as accredited investors under this proposed amendment to the
definition. Using data on private fund statistics compiled by the
Commission's Division of Investment Management, we estimate that there
were 32,202 private funds as of fourth quarter 2018.\114\ However, we
lack data on the number of knowledgeable employees per fund. We also
cannot estimate how many individuals that meet the definition of
``knowledgeable employee'' may already qualify as accredited investors
under the current financial thresholds.
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\114\ See https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2018-q4.pdf.
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The proposed new category of accredited investor would be the same
in scope as the definition of ``knowledgeable employee'' in Rule 3c-
5(a)(4).\115\ It would include, among other persons, trustees and
advisory board members, or persons serving in a
[[Page 2585]]
similar capacity, of a Section 3(c)(1) or 3(c)(7) fund or an affiliated
person of the fund that oversees the fund's investments, as well as
employees of the private fund or the affiliated person of the fund
(other than employees performing solely clerical, secretarial, or
administrative functions) who, in connection with the employees'
regular functions or duties, have participated in the investment
activities of such private fund for at least 12 months.\116\ This new
category would be similar to the existing category for directors,
executive officers, or general partners of the issuer (or directors,
executive officers, or general partners of a general partner of the
issuer).\117\ We believe that such employees, through their knowledge
and active participation of the investment activities of the private
fund, are likely to be financially sophisticated and capable of fending
for themselves in evaluating investments in such private funds.\118\
These employees, by virtue of their position with the fund, are
presumed to have meaningful investing experience and sufficient access
to the information necessary to make informed investment decisions
about the fund's offerings. Allowing these employees to invest in the
funds for which they work also may help to align their interests with
those of other investors in the fund.
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\115\ See proposed Rule 501(a)(11).
\116\ The scope of the term ``knowledgeable employee'' in Rule
3c-5(a)(4) also includes executive officers, directors, and general
partners, or persons servings in a similar capacity, of a Section
3(c)(1) or 3(c)(7) fund or an affiliated person of the fund that
oversees the fund's investments. For these persons, the proposed new
category for ``knowledgeable employees'' in the definition of
``accredited investor'' would overlap with the existing category in
Rule 501(a)(4), which encompasses directors, executive officers, and
general partners of the issuer, as well as directors, executive
officers, and general partners of a general partner of the issuer. A
person is determined to be a knowledgeable employee at the time of
investment. See Rule 3c-5(b)(1).
\117\ Rule 501(a)(4).
\118\ As is the case under Rule 3c-5(a)(4), the scope of
``knowledgeable employees'' under this proposed amendment would not
include employees who simply obtain information but do not
participate in the investment activities of the fund.
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The inclusion of knowledgeable employees in the definition of
``accredited investor'' would also allow these employees to invest in
the private fund without the fund itself losing accredited investor
status when the funds have assets of $5 million or less. Under Rule
501(a)(8), private funds with assets of $5 million or less may qualify
as accredited investors if all of the fund's equity owners are
accredited investors.\119\ Unless they qualify as accredited investors,
these small private funds could otherwise be excluded from
participating in some offerings under Rule 506 that are limited to
accredited investors. Amending the accredited investor definition in
this manner would allow knowledgeable employees to invest in these
small private funds as accredited investors, while permitting the funds
to remain eligible to qualify as accredited investors under Rule
501(a)(8).
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\119\ A private fund may qualify as an accredited investor if it
holds total assets in excess of $5 million and is a corporation,
Massachusetts or similar business trust, or partnership, not formed
for the specific purpose of acquiring the securities offered. A
private fund may also be able to qualify as an accredited investor
if it is a trust with total assets in excess of $5 million that was
not formed for the specific purpose of acquiring the securities
offered, and the purchase is directed by a sophisticated person.
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Request for Comment
15. Should knowledgeable employees of private funds be added to the
definition of accredited investor as proposed?
16. Would adding ``knowledgeable employees'' as a category in the
accredited investor definition raise concerns that small private funds
could qualify as accredited investors under Rule 501(a)(8) when all or
most of its equity owners consist of knowledgeable employees? Do small
private funds raise different concerns than pooled investment funds
such as registered investment companies, business development
companies, and small business investment companies that qualify as
accredited investors without satisfying any quantitative criteria such
as a total assets or investments threshold?
17. Under the proposed definition of ``accredited investor,''
should a knowledgeable employee's accredited investor status be
attributed to his or her spouse and/or dependents when making joint
investments in private funds? Is the answer to this question the same
for a family corporation or similar estate planning vehicle for which
the knowledgeable employee is responsible for investment decisions and
the source of the funds invested?
18. Should the Commission consider including certain types of
employees of a non-fund issuer in the accredited investor definition
for purposes of a securities offering by that issuer? If so, what are
the job types or categories of employees that should be considered to
have the appropriate level of financial sophistication and access to
the information necessary to make informed investment decisions about
the issuer's offerings? For example, would it be appropriate to
consider including officers of an issuer, or employees that serve a
particular function such as employees who oversee the issuer's
financial reporting or business operations? Similarly, should the
Commission consider including other individuals with a familial or
similar relationship to an issuer in the definition for purposes of
such an issuer's securities offering? If so, how should we determine
the appropriate individuals and types of relationships that would be
covered by such a provision?
3. Proposed Note to Rule 501(a)(5)
We are proposing to add a note to Rule 501 to clarify that the
calculation of ``joint net worth'' for purposes of Rule 501(a)(5) can
be the aggregate net worth of an investor and his or her spouse (or
spousal equivalent if ``spousal equivalent'' is included in Rule
501(a)(5), as proposed), and that the securities being purchased by an
investor relying on the joint net worth test of Rule 501(a)(5) need not
be purchased jointly.\120\
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\120\ This proposed note is consistent with an existing staff
interpretation. See question number 255.11 of Securities Act Rules
Compliance and Disclosure Interpretations, available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.
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It does not appear to be necessary, in the accredited investor
context, to limit how an investor takes title to securities or how
spouses own assets. Owning assets separately may be preferable for
estate planning purposes, while owning assets jointly offers a
different set of advantages.\121\ Moreover, nothing in previous
Regulation D releases indicates that the Commission intended the term
``joint'' in Rule 501(a)(5) to require (1) joint ownership of assets
when calculating the net worth of the spouses, or (2) that an investor
relying on the joint net worth test acquire the security jointly
instead of separately. Furthermore, allowing spouses to own assets in
various forms for the purposes of the net worth test is consistent with
how the Commission treats spousal ownership of assets in other
contexts.\122\
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\121\ See Andrea Coombes, Separate Assets, Joint Problems Wall
St. J., (Nov. 10, 2013), available at https://www.wsj.com/articles/separate-assets-joint-problems-1383947655 (noting that separate
ownership may provide certain estate planning advantages and joint
ownership may provide certain creditor protections and
administrative conveniences).
\122\ See Investment Company Act Rule 2a51-1, which permits
separate ownership, joint ownership, and community property
ownership.
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Request for Comment
19. Should we add a note to clarify the calculation of ``joint net
worth'' for purposes of Rule 501(a)(5), as proposed?
[[Page 2586]]
C. Adding Categories of Entities That Qualify as Accredited Investors
The accredited investor definition includes enumerated categories
of entities in paragraphs (1) through (3), (7), and (8) of Rule
501(a).\123\ Any entity not covered specifically by one of the
enumerated categories is not an accredited investor under the rule.
This has resulted in some degree of uncertainty for legal entities of a
type similar to, but not precisely the same as, those entities
specifically enumerated in Rule 501(a). In addition, federal and state
law developments since the adoption of Regulation D have expanded the
types of business entities that exist, and relatively recent concepts,
such as limited liability companies, suggest that developments in this
area are ongoing. Moreover, there are some entities--such as registered
investment advisers--that are not currently enumerated in Rule 501(a)
but that may exhibit attributes of financial sophistication and an
ability to fend for themselves or sustain losses that are similar to
those of enumerated entities. In light of these considerations, we
believe that an expansion of the types of entities that qualify as
accredited investors may reduce uncertainty and legal costs and promote
more efficient private capital formation.
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\123\ See Section II.A above for a summary of the categories of
entities covered by the current rule.
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1. Registered Investment Advisers
We propose to include in Rule 501(a)(1) investment advisers
registered under Section 203 of the Advisers Act \124\ and investment
advisers registered under the laws of the various states. Though these
entities have not previously been included as accredited investors, we
believe it is appropriate to propose including them at this time.
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\124\ See Section 203 of the Investment Advisers Act of 1940 (15
U.S.C. 80b-3).
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As discussed above, the definition of ``accredited person'' in
former Rule 242 is the antecedent to the current accredited investor
definition. Adopted in 1980, Rule 242 was an exemption from
registration for sales to an unlimited number of ``accredited persons''
and to 35 other purchasers.\125\ Included as accredited persons were
certain institutional investors: Banks, insurance companies, certain
employee benefit plans, investment companies, and small business
investment companies (``SBICs''). Regarding which institutions were to
be included in this list, the Commission noted that ``[t]he definition
of accredited person is similar to provisions found in state securities
laws, in the ALI Federal Securities Code, and in proposed
legislation,'' \126\ none of which included registered investment
advisers. In adopting Regulation D, the Commission used Rule 242's list
of institutional investors, adding only business development
companies.\127\
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\125\ See Rule 242 Adopting Release at 6363.
\126\ See Exemption of Limited Offers and Sales by Corporate
Issuers, Release No. 33-6121 (September 11, 1979) [44 FR 54258 at
54259 (Sept. 18, 1979)].
\127\ See Regulation D 1982 Adopting Release.
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When the Commission amended the definition of accredited investor
in 1988 to include savings and loan associations, credit unions, and
registered broker-dealers, the Commission stated that there did not
appear to be a compelling reason to distinguish these newly included
institutions from those that were already treated as accredited
investors, noting that most states already treated these new entities
as institutional investors.\128\
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\128\ See Regulation D 1988 Adopting Release at 7866, noting
that ``[m]ost of the states in their institutional investor
exemptions already exempt securities offerings to these categories
of investors.'' See also footnote 11 of the Regulation D 1988
Adopting Release, describing Section 402(b)(8) of the Uniform
Securities Act which ``exempts any offer or sale to a bank, savings
institution, trust company, insurance company, investment company as
defined in the Investment Company Act of 1940, pension or profit
sharing trust, or other financial institution or institutional
buyer, or to a broker-dealer, whether the purchaser is acting for
itself or in some fiduciary capacity.''
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The Uniform Securities Act \129\ was amended in 2002, and the
definition of institutional investor therein was expanded to include,
among others, SEC-registered investment advisers acting for their own
accounts.\130\ Twenty states have adopted a version of the 2002 Uniform
Securities Act.\131\ As registered investment advisers are now
generally considered to be institutional investors under state law,
following the rationale the Commission applied in 1988, we see no
compelling reason to distinguish SEC- and state-registered investment
advisers from those institutional investors already treated as
accredited investors.
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\129\ The Uniform Securities Act was developed by the National
Conference of Commissioners on Uniform State Laws as a model
securities regulation statute that the states could choose to use as
a basis for their own statutes. See https://www.uniformlaws.org/HigherLogic/System/DownloadDocumentFile.ashx?DocumentFileKey=9b2b8f23-651c-c727-e234-3af8b5ab1b6e&forceDialog=0.
\130\ See Section 102(11) of the Uniform Securities Act (2002).
See also Section 202(13) of the Uniform Securities Act (2002)
(exempting a sale or offer to sell to an institutional investor from
certain registration and filing requirements).
\131\ See https://www.uniformlaws.org/committees/community-home?CommunityKey=8c3c2581-0fea-4e91-8a50-27eee58da1cf.
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We estimate that there are currently approximately 13,400 SEC-
registered investment advisers and approximately 17,500 state-
registered investment advisers that would be covered by the proposed
rule change. We are not able to estimate how many of those SEC- or
state-registered investment advisers may meet the $5 million assets
test under Rule 501(a)(3) and therefore currently qualify as accredited
investors. Because registered investment advisers, like the other
entity types listed in Rule 501(a)(1), appear to have the requisite
financial sophistication needed to conduct meaningful investment
analysis, we believe it is appropriate to extend accredited investor
status to all SEC- and state-registered investment advisers.
Request for Comment
20. Should SEC- and state-registered investment advisers be added
to the list of entities specified in Rule 501(a)(1) and qualify as
accredited investors, as proposed? Alternatively, should only SEC-
registered investment advisers qualify as accredited investors? If so,
why? Should we allow exempt reporting advisers to qualify as accredited
investors? \132\ If so, should exempt reporting advisers be subject to
additional conditions?
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\132\ An exempt reporting adviser is an investment adviser that
qualifies for the exemption from registration under Section 203(l)
of the Advisers Act because it is an adviser solely to one or more
venture capital funds, or under Rule 203(m)-1 of the Advisers Act
because it is an adviser solely to private funds and has assets
under management in the United States of less than $150 million. See
Exemptions for Advisers to Venture Capital Funds, Private Fund
Advisers With Less Than $150 Million in Assets Under Management, and
Foreign Private Advisers, Investment Advisers Act Release No. 3222
(June 22, 2011) [76 FR 39646 (July 6, 2011)].
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2. Rural Business Investment Companies
A rural business investment company (``RBIC'') is defined in
Section 384A of the Consolidated Farm and Rural Development Act \133\
as a company that is approved by the Secretary of Agriculture and that
has entered into a participation agreement with the Secretary.\134\
RBICs are intended to promote economic development and the creation of
wealth and job opportunities in rural areas and among individuals
[[Page 2587]]
living in such areas.\135\ Their purpose is similar to the purpose of
SBICs, which are intended to increase access to capital for growth
stage businesses.\136\ Because SBICs and RBICs share the common purpose
of promoting capital formation in their respective sectors, advisers to
SBICs and RBICs are treated similarly under the Advisers Act in that
they have the opportunity to take advantage of expanded exemptions from
investment adviser registration.\137\ Because of their common purpose,
we also believe they should be treated similarly under the Securities
Act. SBICs are already accredited investors under Rule 501(a)(1). We
therefore propose to include RBICs as accredited investors under Rule
501(a)(1).
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\133\ 7 U.S.C. 2009cc.
\134\ See Public Law 115-417 (2019). To be eligible to
participate as an RBIC, the company must be a newly formed for-
profit entity or a newly formed for-profit subsidiary of such an
entity, have a management team with experience in community
development financing or relevant venture capital financing, and
invest in enterprises that will create wealth and job opportunities
in rural areas, with an emphasis on smaller enterprises. See 7
U.S.C. 2009cc-3(a).
\135\ http://www.rd.usda.gov/programs-services/rural-business-investment-program.
\136\ https://www.sba.gov/partners/sbics.
\137\ Advisers to solely RBICs and advisers to solely SBICs are
exempt from investment adviser registration. Advisers Act Sections
203(b)(8) and 203(b)(7), respectively. The venture capital fund
adviser exemption deems RBICs and SBICs to be venture capital funds
for purposes of the exemption. 15 U.S.C. 80b-3(l). The private fund
adviser exemption excludes the assets of RBICs and SBICs from
counting towards the $150 million threshold. 15 U.S.C. 80b-3(m).
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Request for Comment
21. Should RBICs be added to the list of entities specified in Rule
501(a)(1) and qualify as accredited investors, as proposed? Is there
any reason to treat RBICs differently than SBICs in this regard?
3. Limited Liability Companies
Rule 501(a)(3) sets forth the following types of entities that
qualify for accredited investor status if they have total assets in
excess of $5 million and were not formed for the specific purpose of
acquiring the securities being offered: Organizations described in
section 501(c)(3) of the Internal Revenue Code, corporations,
Massachusetts or similar business trusts, and partnerships.\138\ This
list does not include limited liability companies, which have become a
widely adopted corporate form since the Commission last updated the
accredited investor rules in 1989 to include additional entities.\139\
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\138\ See Rule 501(a)(3).
\139\ See Regulation D 1989 Adopting Release.
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In 1977, the state of Wyoming was the first state to enact a
statute authorizing the creation of a limited liability company.\140\
However, more widespread adoption of the limited liability company as a
corporate form did not occur until more than a decade later.\141\
Indeed, it took until 1996 for all fifty states to enact limited
liability company statutes.\142\ The slow adoption of the limited
liability company as a corporate form may help explain why limited
liability companies were not included in the Regulation D 1982 Adopting
Release, the Regulation D 1988 Adopting Release, or the Regulation D
1989 Adopting Release, which together expanded Rule 501(a)(3) to
include the enumerated list as it exists today.
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\140\ See Susan Pace Hamill, ``The Story of LLCs: Combining the
Best Features of a Flawed Business Tax Structure'' in Business Tax
Stories: An In-Depth Look at Ten Leading Developments in Corporate
and Partnership Taxation (Foundation Press, 2005), available at
https://www.law.ua.edu/misc/bio/hamill/Chapter%2010--Business%20Tax%20Stories%20(Foundation).pdf.
\141\ Id. at 297 (noting that the State of Florida enacted a
limited liability company statute in 1982, but that the next state
to adopt a similar statute did not do so until 1990).
\142\ Id.
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Given the widespread adoption of the limited liability company as a
corporate form, we propose to include limited liability companies in
Rule 501(a)(3). The proposed amendment would codify a longstanding
staff position that limited liability companies that satisfy the other
requirements of the definition are eligible to qualify as accredited
investors under Rule 501(a)(3).\143\ One commenter responding to the
Concept Release supported the inclusion of limited liability companies
as accredited investors under Rule 501(a)(3).\144\
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\143\ See Division of Corporation Finance interpretive letter to
Wolf, Block, Schorr and Solis-Cohen (Dec. 11, 1996); and question
number 255.05 of Securities Act Rules Compliance and Disclosure
Interpretations, available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.
\144\ See MFA and AIMA Letter.
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Due to a lack of publicly available information about limited
liability companies, we are unable to estimate the number of limited
liability companies that would qualify as accredited investors under
the proposed rule. We believe that limited liability companies that
meet the requirements of Rule 501(a)(3), including the assets test,
should be considered to have the requisite financial sophistication to
qualify as accredited investors. Moreover, we are not aware of abuses
or concerns associated with the current treatment of limited liability
companies that satisfy the other requirements of the definition as
accredited investors that would warrant their exclusion from the
definition.
We are aware that some individuals may prefer to make investments
through an entity instead of on an individual basis, and we understand
that frequently such individuals will opt to use the limited liability
company form of organization. In such cases, the limited liability
company may not qualify under Rule 501(a)(3) if it was formed for the
specific purpose of acquiring the securities being offered, regardless
of the amount of assets held by the LLC. However, because Rule
501(a)(8) accredits any entity in which all of the equity owners are
accredited investors, a limited liability company formed for this
purpose may still qualify as an accredited investor under such
rule.\145\
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\145\ As discussed below in Section II.C.5, we are proposing to
add a note to Rule 501(a)(8) that would clarify the application of
Rule 501(a)(8) when the equity owner is itself an entity rather than
a natural person.
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We note that Rule 501(a)(4) includes as an accredited investor any
director, executive officer, or general partner of the issuer of the
securities being offered or sold. The term ``executive officer'' is
defined in Rule 501(f) as ``the president, any vice president in charge
of a principal business unit, division or function, as well as any
other officer who performs a policy making function, or any other
person who performs similar policy making functions for the issuer.''
We are of the view that a manager of a limited liability company
performs a policy making function for the issuer equivalent to that of
an executive officer of a corporation under Rule 501(f), and therefore
we do not believe it is necessary to amend Rule 501(a)(4) or Rule
501(f) to specifically include managers of limited liability companies.
We believe that such managers, through their knowledge and management
of the issuer, are likely to be sophisticated financially and capable
of fending for themselves in evaluating investments in the limited
liability company's securities.
Request for Comment
22. Should limited liability companies be added to the list of
entities specified in Rule 501(a)(3), as proposed?
23. If limited liability companies are listed in Rule 501(a)(3),
should we further amend our rules to specifically include managers of
limited liability companies as executive officers under Rule 501(f)?
Instead of all managers, should we limit this provision to managing
members, which would preclude third-party managers from being
considered executive officers under Rule 501(f)? Alternatively, should
we include managers of limited liability companies in Rule 501(a)(4)'s
list of insiders who may qualify as accredited investors?
[[Page 2588]]
4. Other Entities Meeting an Investments-Owned Test
In addition to limited liability companies, other types of
entities, such as Indian tribes, labor unions, governmental bodies and
funds, and entities organized under the laws of a foreign country, are
not specifically listed in the accredited investor definition.
In the 2015 Staff Report, the Commission staff recommended that the
Commission ``consider modifying the definition to permit any entity
with investments in excess of $5 million, and not formed for the
specific purpose of investing in the securities offered, to qualify as
an accredited investor.'' \146\ The staff noted that a definition of
investments ``based on the definition of investments in Rule 2a51-1(b)
would promote consistency across securities laws and provide a
predictable framework.'' \147\ Responses were mixed, with several
commenters supporting the recommendation \148\ and other commenters
opposing it.\149\
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\146\ See 2015 Staff Report at 92.
\147\ Id.
\148\ See, e.g., letter from the Small Business Investor
Alliance dated March 7, 2016 (``2016 SBIA Letter''); NSBA Letter;
and 2016 NASAA Letter (``An investments test is a better gauge of
financial sophistication than simply analyzing net worth or
income'').
\149\ See, e.g., K. Beagle Letter; Cornell Law Clinic Letter;
and Reardon Letter.
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The Concept Release requested comment on whether the Commission
should revise the definition to expand the types of entities that may
qualify as accredited investors, and if so, what types of entities
should be included. Several commenters supported expanding the
definition to include specific additional entity types, including
Indian tribes \150\ and certain state and local governmental
entities.\151\
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\150\ See CrowdCheck Letter; NAFOA Letter; G. Clarkson Letter;
J. Wallin Letter; REDCO Letter; and IMDG Letter. The NAFOA Letter,
which the G. Clarkson Letter, J. Wallin Letter, REDCO Letter, and
IMDG Letter all supported, recommended revising Rule 501(a)(1) to
include ``any plan established and maintained by a tribal
government, its political subdivisions, or any agency or
instrumentality of a tribal government or its political
subdivisions, for the benefit of its citizens (members), if such
plan has total assets in excess of $5,000,000 in non-trust assets,''
with the term ``non-trust asset'' defined as ``an asset that is
under the direct control of a tribe or tribal entity, and which is
not held in trust by the United States for the benefit of the
tribe.'' In addition, the 2019 Small Business Forum Report included
a recommendation that the Commission revise the accredited investor
definition to provide tribal governments parity with state
governments.
\151\ See CMTA Letter (supporting the inclusion of state and
local governments having $100 million of assets under management as
accredited investors).
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The Concept Release also requested comment on whether the
Commission should replace all $5-million-total-assets thresholds with
$5-million-total-investments thresholds, while including all entities
instead of enumerating certain entities. While one commenter opposed
replacing the asset test with an investments test,\152\ several
commenters supported allowing all entities owning $5 million in
investments to qualify as an accredited investor.\153\
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\152\ See IPA Letter (asserting that such a change would
``unduly [shrink] the current pool of eligible investors'').
\153\ See CMTA Letter; EquityZen Letter; ICI Letter; BlackRock
Letter; Artivest Letter; ABA FR of Sec. Comm. Letter; Sec. Reg.
Comm. of N.Y.St. B.A. Letter; and letter from PFM Asset Management
LLC dated December 6, 2019 (``PFM Letter'').
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In response to these comments and recommendations, we are proposing
to add a new category in the accredited investor definition for any
entity owning investments in excess of $5 million that is not formed
for the specific purpose of acquiring the securities being
offered.\154\ As shown by the emergence of limited liability companies,
it is possible that an entirely new corporate form could gain
acceptance but not come within the scope of Rule 501(a). Proposed Rule
501(a)(9) is intended to capture all existing entity forms not already
included within Rule 501(a), such as Indian tribes and governmental
bodies, as well as those entity types that may be created in the
future.
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\154\ Proposed Rule 501(a)(9).
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We believe requiring $5 million in investments instead of assets
for this ``catch-all'' category of entities may better demonstrate that
the investor has experience in investing and is therefore more likely
to have a level of financial sophistication similar to that of other
institutional accredited investors. For example, certain types of
entities that would be covered by the proposed amendment, such as
governmental entities, may have $5 million in non-financial assets such
as land, buildings, and vehicles, but not have any investment
experience. With respect to this new category of entities, we believe
that an investments test may be more likely than an assets-based test
to serve as a reliable method for ascertaining whether an entity is
likely to require the protections of Securities Act registration.
To assist both issuers and investors, we propose to incorporate the
definition of investments from Rule 2a51-1(b) under the Investment
Company Act, which includes, among other things: securities; real
estate, commodity interests, physical commodities, and non-security
financial contracts held for investment purposes; and cash and cash
equivalents.\155\ By using an existing definition, we hope to alleviate
confusion and facilitate compliance.
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\155\ See Rule 2a51-1(b), which was adopted by the Commission in
Privately Offered Investment Companies, Release No. IC-22597 (Apr.
3, 1997) [62 FR 17512 (April 9, 1997)].
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Request for Comment
24. Should we add a new category to the accredited investor
definition for any entity with investments in excess of $5 million that
is not formed for the specific purpose of acquiring the securities
being offered, while maintaining the current $5 million assets test for
entities currently listed in Rules 501(a)(3) and (a)(7), as proposed?
Are the entities that would be eligible under proposed Rule 501(a)(9)
sufficiently different in nature from the enumerated entities in Rules
501(a)(3) and (a)(7) such that an investment test should be applied to
demonstrate financial sophistication? If not, should Rule 501(a)(3) be
expanded to include any entity that has more than $5 million in assets?
25. Instead of using the catch-all ``any entity'' in proposed Rule
501(a)(9), should we enumerate specific entity types? If so, which
entity types should we enumerate?
26. Should any restrictions be applied with respect to entities
covered by proposed Rule 501(a)(9)? For example, should we consider any
restrictions on entities organized or incorporated under the laws of a
foreign country?
27. Should we use an asset test instead of an investments test in
proposed Rule 501(a)(9)? Should the current $5 million asset test be
adjusted?
28. Is $5 million in investments the appropriate threshold for the
proposed new category?
29. Proposed Rule 501(a)(9) is intended to capture all existing
entity forms not already included within Rule 501(a), including Indian
tribes and governmental bodies, that meet the proposed $5 million
investments test. Would the investments test have a disproportionate
impact on Indian tribes?
30. Should we use the definition of investments from Rule 2a51-1(b)
under the Investment Company Act? If not, what definition should we
use? Are market participants familiar with the definition such that
implementation would not be unduly difficult?
31. We are not proposing to revise Rule 501(a)(7). As a result,
trusts with investments of more than $5 million would not need
purchases to be directed by a sophisticated person in order to
[[Page 2589]]
qualify as an accredited investor. Is this an appropriate result?
Should trusts have purchases directed by a sophisticated person in
order to qualify under proposed Rule 501(a)(9)?
32. In addition to, or in lieu of, proposed Rule 501(a)(9), should
we revise the definition of accredited investor by replacing the $5
million assets test that currently applies to certain entities with a
$5 million investments test? If so, should we also grandfather issuers'
existing investors that are accredited investors under the current
definition with respect to future offerings of their securities?
Alternatively, should we retain the current assets test but revise the
$5 million threshold? If so, what threshold would be appropriate?
5. Proposed Note to Rule 501(a)(8)
Under Rule 501(a)(8), an entity qualifies as an accredited investor
if all of the equity owners of that entity are accredited investors.
Because in some instances, an equity owner of an entity is another
entity, not a natural person, we are proposing to add a note to Rule
501(a)(8) that would clarify that, in determining accredited investor
status under Rule 501(a)(8), one may look through various forms of
equity ownership to natural persons.\156\ Thus, if those natural
persons are themselves accredited investors, and if all other equity
owners of the entity are accredited investors, the entity would be an
accredited investor under Rule 501(a)(8). We believe this approach is
appropriate because the intent of Rule 501(a)(8) is to qualify as
accredited investors those entities that are 100% owned by accredited
investors and, for this purpose, it should not matter whether the
ownership is direct or indirect.
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\156\ This proposed note is consistent with an existing staff
interpretation. See question number 255.06 of Securities Act Rules
Compliance and Disclosure Interpretations, available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.
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Request for Comment
33. Should we add a note to clarify that one may look through
various forms of equity ownership to natural persons when determining
accredited investor status under Rule 501(a)(8)?
6. Certain Family Offices and Family Clients
In response to the 2015 Staff Report, the Commission received
comments from a group of ``family offices'' recommending that the
Commission amend the accredited investor definition to include ``family
offices'' and ``family clients,'' as the Commission has defined those
terms.\157\ ``Family offices'' are entities established by wealthy
families to manage their wealth, plan for their families' financial
future, and provide other services to family members. The Commission
has previously observed that single family offices generally serve
families with at least $100 million or more of investable assets.\158\
Family offices generally meet the definition of ``investment adviser''
under the Advisers Act, as the Commission has interpreted the term,
because, among the variety of services provided, family offices are in
the business of providing advice about securities for compensation.
However, the Commission adopted the ``family office rule'' \159\ in
2011 to exclude single family offices from regulation under the
Advisers Act under certain conditions.\160\ Under that rule, a family
office generally is a company that has no clients other than ``family
clients.'' \161\ ``Family clients'' generally are family members,
former family members, and certain key employees of the family office,
as well as certain of their charitable organizations, trusts, and other
types of entities.\162\
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\157\ See letter from Martin E. Lybecker, Perkins Coie LLP (on
behalf of Private Investor Coalition) dated August 8, 2016 (``2016
PIC Letter'').
\158\ See Family Offices, Release No. IA-3098 (Oct. 12, 2010)
[75 FR 63753 (Oct. 18, 2010)] (``Family Office Proposing Release'').
Industry observers have estimated that there are 2,500 to 3,000
single family offices managing more than $1.2 trillion in assets.
See 2016 PIC Letter.
\159\ 17 CFR 275.202(a)(11)(G)-1.
\160\ See Family Offices, Release No. IA-3220 (June 22, 2011)
[76 FR 37983 (June 29, 2011)] (``Family Office Adopting Release'').
See also Family Office Proposing Release (``We viewed the typical
single family office as not the sort of arrangement that Congress
designed the Advisers Act to regulate. We also were concerned that
application of the Advisers Act would intrude on the privacy of
family members. . . . The Act was not designed to regulate the
interactions of family members in the management of their own
wealth.'').
\161\ A family office also (1) must be wholly owned by family
clients and exclusively controlled (directly or indirectly) by one
or more family members or family entities (each as defined in the
rule), and (2) must not hold itself out to the public as an
investment adviser. See Rule 202(a)(11)(G)-1(b).
\162\ For a full list of family clients, see 17 CFR
275.202(a)(11)(G)-1(d)(4). The family office rule defines a ``family
member'' to include ``all lineal descendants (including by adoption,
stepchildren, foster children, and individuals that were a minor
when another family member became a legal guardian of that
individual) of a common ancestor (who may be living or deceased),
and such lineal descendants' spouses or spousal equivalents;
provided that the common ancestor is no more than 10 generations
removed from the youngest generation of family members.'' 17
CFRSec. 275.202(a)(11)(G)-1(d)(6).
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A commenter on the 2015 Staff Report stated that the public policy
supporting the family office rule ``is based on the notion that members
of a family will protect each other, and that the investor protections
of the Investment Advisers Act do not need to apply. . . .'' \163\ The
commenter suggested this public policy should apply to other securities
laws as well.\164\ The commenter also explained that the different
standards under Commission rules sometimes result in an anomaly that a
particular family client might not meet the definition of accredited
investor while it could meet the definition of ``qualified purchaser,''
\165\ which has a higher financial threshold. The commenter reiterated
these assertions in its recent comment letter on the Concept Release
and suggested that we add a new category of investor to the accredited
investor definition that would apply to ``(i) a Family Office with
assets under management in excess of $5,000,000 and (ii) a Family
Office or a Family Client (a) that is not formed for the specific
purpose of acquiring the securities offered and (b) whose purchase is
directed by a person who has such knowledge and experience in financial
and business matters that such person is capable of evaluating the
merits and risks of a potential investment.'' \166\ Another commenter
on the Concept Release raised similar points and urged the Commission
to, among other things, amend the definition of accredited investor to
include a family client of a family office so long as it relied on
advice and sophistication of the family office.\167\
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\163\ See 2016 PIC Letter.
\164\ See Id. (recommending changes not only to the definition
of ``accredited investor,'' but also to the definitions of
``qualified purchaser'' and ``investment company'' in the Investment
Company Act).
\165\ Investment Company Act Section 2(a)(51)(A) (15 U.S.C. 80a-
2(a)(51)(A)).
\166\ See 2019 PIC Letter.
\167\ See letter from Institutional Limited Partners Association
dated September 24, 2019.
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We believe the policy rationale for adopting the family office rule
also supports considering amendments to the definition of accredited
investor for family offices and their family clients. We believe family
offices can sustain the risk of loss of investment, given their assets.
As a result, we are proposing to add new categories to the accredited
investor definition for ``family offices'' and ``family clients of
family offices.''
Drawing from characteristics in the current definition of
accredited investor and from commenter feedback, we propose to amend
the definition to include any ``family office'' with at least $5
million in assets under
[[Page 2590]]
management \168\ and its ``family clients,'' \169\ each as defined in
the family office rule. We believe requiring the family office to have
a minimum amount of assets under management, as suggested by
commenters, would ensure the family office has sufficient assets to
sustain the risk of loss. In addition, the proposed definition would
apply only to a family office whose purchase is 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. In order to avoid improper reliance on
the amended rule, we also propose that the family office not be formed
for the specific purpose of acquiring the securities offered \170\ and
that a family client must be a family client of a family office that
meets these requirements.\171\ We expect that all or most current
family offices would be accredited investors under the proposed
amendments to the definition.
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\168\ Proposed Rule 501(a)(12).
\169\ Proposed Rule 501(a)(13).
\170\ Proposed Rule 501(a)(12)(i).
\171\ Proposed Rule 501(a)(13).
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Request for Comment
34. Should family offices and their family clients qualify as
accredited investors?
35. Do the proposed new categories for these investors have the
proper scope? If not, what parameters would be more appropriate? If
yes, which ones and why? If not, why not? Are we correct that all or
most family offices and their clients would qualify as accredited
investors under the proposed amendments?
36. Should we require that the purchase be directed by a person who
has the requisite knowledge and experience in financial and business
matters? How would issuers assess this in practice?
37. Would it be appropriate to impose a financial threshold for a
family office to qualify as an accredited investor as proposed? Should
we also impose a financial threshold for a family client to qualify? In
either case, what is the appropriate threshold? For instance, should
there be a minimum investment amount or minimum assets under
management?
38. Are there specific categories of family clients that should be
excluded? For instance, should the proposed rule exclude anyone who is
not a ``family member,'' as defined in the family office rule? \172\
Should a family client qualify as an accredited investor if it becomes
a ``former family client,'' as defined in the family office rule? \173\
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\172\ See Rule 202(a)(11)(G)-1(d)(6).
\173\ See Rule 202(a)(11)(G)-1(d)(7).
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39. Rule 202(a)(11)(G) 1 under the Advisers Act deems a person who
receives assets upon the death of a family member (or other involuntary
transfer from a family member) to be a family client (``a
beneficiary'') for only one year following the involuntary
transfer.\174\ Should such a beneficiary qualify as an accredited
investor during that year if the beneficiary would not otherwise
qualify?
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\174\ See Rule 202(a)(11)(G) 1(b).
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D. Permit Spousal Equivalents To Pool Finances for the Purposes of
Qualifying as Accredited Investors
Under the current accredited investor definition, an individual,
together with a spouse, may qualify as an accredited investor by either
surpassing the $300,000 joint income threshold \175\ or the $1 million
joint net worth threshold.\176\ The Commission did not define the term
``spouse'' when it originally adopted Regulation D,\177\ nor did it do
so when adding the joint income test to the accredited investor
definition in 1988.\178\ Currently, references to ``spouse'' in Rule
501 include individuals married to persons of the same sex.
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\175\ Rule 501(a)(6).
\176\ Rule 501(a)(5).
\177\ See Regulation D 1982 Adopting Release.
\178\ See Regulation D 1988 Adopting Release.
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The 2015 Staff Report noted uncertainties regarding whether persons
in legally recognized unions, such as domestic partnerships, civil
unions, and same-sex marriages, were considered spouses for purposes of
the accredited investor definition. The 2015 Staff Report recommended
that the Commission consider adding the term ``spousal equivalent'' to
the accredited investor definition to permit spousal equivalents to
pool finances for the purpose of qualifying as accredited investors.
Commenters' responses were mixed, with several commenters generally
supporting the recommendation \179\ and one commenter opposing it.\180\
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\179\ See CFA/AFR Letter (stating that this recommended change
``helps to bring the securities laws up to date with modern values
and expectations''); NSBA Letter (noting that this recommended
change would ``expand opportunities to invest in small businesses to
more households''); and 2016 SBIA Letter.
\180\ See Cornell Law Clinic Letter (noting that federal law
does not treat marriages as equivalent to civil unions and domestic
partnerships, and that ``the family office rule, accountant
independence standards, and crowdfunding rules are fundamentally
different in nature from the accredited investor definition'').
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To address any uncertainties, we propose to allow natural persons
to include joint income from spousal equivalents when calculating joint
income under Rule 501(a)(6), and to include spousal equivalents when
determining net worth under Rule 501(a)(5). We see no reason to
distinguish between different types of relationship structures for the
purpose of these rules and, in that regard, believe that the proposed
amendments would remove unnecessary barriers to investment
opportunities for spousal equivalents.
The proposed amendments would define spousal equivalent as a
cohabitant occupying a relationship generally equivalent to that of a
spouse. The Commission previously has used this formulation of spousal
equivalent.\181\ As discussed above, a family office is exempted from
regulation under the Advisers Act when the family office advises
``family clients.'' \182\ The Commission defined ``family clients'' to
include ``family members,'' of which ``spousal equivalents'' are a
part, with ``spousal equivalent'' defined as a cohabitant occupying a
relationship generally equivalent to that of a spouse.\183\ The
crowdfunding rules adopted to implement the requirements of Title III
of the JOBS Act also use this definition of ``spousal equivalent.''
\184\ In Regulation Crowdfunding, the Commission included the term
``spousal equivalent'' in the definition of the term ``member of the
family of the purchaser or the equivalent,'' with ``spousal
equivalent'' having the same definition used in the Advisers Act and as
the one we propose in this release.\185\ In response to the Concept
Release, several commenters supported allowing spousal equivalents to
pool finances for purposes of qualifying as accredited investors.\186\
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\181\ Though the Commission rule governing accountant
independence also includes ``spousal equivalents,'' the term is not
defined in that rule. See 17 CFR 210.2-01.
\182\ See Family Office Adopting Release.
\183\ Rule 202(a)(11)(G) 1(d)(9).
\184\ The JOBS Act provides that securities issued in reliance
on the crowdfunding exemption may not be transferred by the
purchaser for one year after the date of purchase, except when
transferred to, among other persons, ``a member of the family of the
purchaser or the equivalent'' (emphasis added). JOBS Act Section
302(e)(1)(D).
\185\ 17 CFR 227.501(c).
\186\ See J. Wallin Letter; EquityZen Letter; 2019 SBIA Letter;
IPA Letter; Artivest Letter; ABA FR of Sec. Comm. Letter; Sec. Reg.
Comm. of N.Y.St. B.A. Letter; and CrowdCheck Letter. In addition to
these comments, the Commission previously received a request for
rulemaking petition from David L. Dallas, Jr. dated September 16,
2013, available at https://www.sec.gov/rules/petitions/2013/petn4-665.pdf, requesting that the Commission ``revise Rule 501 of
Regulation D to afford to persons in civil unions, domestic
partnerships, and similar relationships, the same right and
opportunity to qualify for accredited investor status as married
persons have.''
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[[Page 2591]]
We see no need to deviate from the definition of ``spousal
equivalent'' already used in Commission rules. Revising Rule 501(a)(5)
and (6) to permit spousal equivalents to pool their financial resources
would promote consistency with these existing rules.
Request for Comment
40. Should we allow spousal equivalents to pool finances for the
purpose of qualifying as accredited investors? If so, is our proposed
definition of ``spousal equivalent'' appropriate? If not, what
definition should we use?
E. Proposed Amendment to Rule 215
Rule 215 defines the term ``accredited investor'' under Section
2(a)(15) of the Securities Act \187\ for purposes of Section 4(a)(5) of
the Securities Act.\188\ The accredited investor definition in Rule 215
has historically been substantially consistent but not identical to the
accredited investor definition in Rule 501(a) of Regulation D. For
example, in contrast to the definition in Rule 501(a), the scope of the
accredited investor definition in Rule 215 does not include banks,
insurance companies, registered investment companies, business
development companies as defined in Section 2(a)(48) of the Investment
Company Act, or SBICs. In addition, the accredited investor definition
in Rule 215 does not contain a reasonable belief standard as in Rule
501(a).\189\
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\187\ 15 U.S.C. 77b(a)(15). Section 2(a)(15) sets forth an
enumerated list of entities that qualify as accredited investors as
well as ``any person who, on the basis of such factors as financial
sophistication, net worth, knowledge, and experience in financial
matters, or amount of assets under management qualifies as an
accredited investor under rules and regulations which the Commission
shall prescribe.''
\188\ 15 U.S.C. 77d(a)(5). Section 4(a)(5) of the Securities Act
provides an exemption for issuers for the offer and sale of
securities to accredited investors if the aggregate offering amount
does not exceed $5 million; the issuer, or anyone acting on its
behalf, does not engage in general solicitation or general
advertising; and the issuer files a notice on Form D with the
Commission. Based on DERA staff's review of Form D filings from
January 1, 2009 through November 30, 2019, no issuer reported
relying on the Section 4(a)(5) exemption during that time period.
\189\ Under Rule 501(a), natural persons and entities that come
within any of eight enumerated categories in the definition, or that
the issuer reasonably believes comes within any of the categories,
are accredited investors.
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We propose to amend the accredited investor definition in Rule 215
to conform to the amendments to the accredited investor definition in
Rule 501(a). To ensure uniformity in the accredited investor definition
in both provisions, we propose to replace the existing definition in
Rule 215 with a cross reference to the accredited investor definition
in Rule 501(a). By including this cross reference, the definition of
``accredited investor'' in Rule 215 as amended would be expanded to
include any amendments to the accredited investor definition in Rule
501(a), as well as those entities that are presently included in the
definition in Rule 501(a) but not the definition in Rule 215. As
amended, the definition would also contain the same reasonable belief
standard as in Rule 501(a).
Request for Comment
41. Should the Commission amend Rule 215 by replacing the existing
text with a cross reference to the accredited investor definition in
Rule 501(a) as proposed? Should the Commission instead incorporate any
amendments to the accredited investor definition in the text of Rule
215?
42. Would amending the scope of the accredited investor definition
in Rule 215 to encompass any amendments to the accredited investor
definition in Rule 501(a) as well as certain entities that are
currently included in the definition in Rule 501(a) raise concerns
regarding the application of the Section 4(a)(5) exemption? Would
adding a reasonable belief standard to the definition in Rule 215 raise
concerns?
43. Would the proposed amendment to the accredited investor
definition in Rule 215 affect an issuer's considerations in determining
whether to use the Section 4(a)(5) exemption? Would issuers be more
likely to use the Section 4(a)(5) exemption?
F. Proposed Amendment to Rule 163B
In registered offerings under the Securities Act, issuers may
engage in test-the-waters communications with qualified institutional
buyers or institutional accredited investors to gauge their interest in
a contemplated offering. Under Section 5(d) of the Securities Act, an
emerging growth company, as defined in Securities Act Rule 405, is
permitted to engage in oral or written communications with potential
investors that are either qualified institutional buyers, as defined in
Rule 144A(a)(1), or institutions that are accredited investors as
defined in Rule 501(a), to offer securities before or after the filing
of a registration statement. In September 2019, the Commission adopted
Securities Act Rule 163B, which extends this testing-the-waters
accommodation to all issuers.\190\ Pursuant to Rule 163B, an issuer may
engage in test-the-waters communications with potential investors that
are, or that the issuer or person authorized to act on its behalf
reasonably believes are, qualified institutional buyers, as defined in
Rule 144A, or institutions that are accredited investors, as defined in
Rule 501(a)(1), (a)(2), (a)(3), (a)(7), or (a)(8).
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\190\ Solicitations of Interest Prior to a Registered Public
Offering, Release No. 33-10699 (Sept. 25, 2019) [84 FR 53011 (Oct.
4, 2019)].
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In connection with the proposed amendments to the accredited
investor definition in Rule 501(a), we propose to amend Rule 163B to
include a reference to proposed Rules 501(a)(9) and (a)(12). The
proposed amendment to Rule 163B would maintain consistency between Rule
163B and Section 5(d), in that institutional accredited investors under
proposed Rules 501(a)(9) and (a)(12), if adopted, would automatically
fall within the scope of Section 5(d). We believe that expanding the
types of entities with whom an issuer may engage in these test-the-
waters communications, by amending the accredited investor definition
and the qualified institutional buyer definition,\191\ may increase the
use of Rule 163B, as well as Section 5(d), and may result in issuers
more effectively gauging market interest in contemplated registered
offerings. We also believe that the expanded scope of entities that
would receive these test-the-waters communications under the proposed
amendment to Rule 163B have the financial sophistication to process
this information and to review the registration statement that is filed
with the Commission against the test-the-waters materials before making
an investment decision.
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\191\ The proposed amendments to the qualified institutional
buyer definition in Rule 144A are discussed below in Section IV.
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Request for Comment
44. Should the Commission amend Securities Act Rule 163B to include
a reference to proposed Rules 501(a)(9) and (a)(12)?
45. Would the proposed amendments to the accredited investor
definition and the qualified institutional buyer definition raise
concerns in connection with the test-the-waters communications that
issuers may engage in pursuant to Rule 163B or Section 5(d) of the
Securities Act?
G. Proposed Amendment to Exchange Act Rule 15g-1
Pursuant to Exchange Act Rule 15g-2 through Rule 15g-6, broker-
dealers are required to disclose certain specified
[[Page 2592]]
information to their customers prior to effecting a transaction in a
``penny stock,'' as defined in 17 CFR 240.3a51-1 under the Exchange
Act.\192\ Rule 15g-1 under the Exchange Act exempts certain
transactions from these disclosure requirements. In particular,
paragraph (b) of Rule 15g-1 exempts transactions in which the customer
is an institutional accredited investor, as defined in Rule 501(a)(1),
(2), (3), (7), or (8) of Regulation D.\193\
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\192\ Rules 15g-1 through 15g-9 under the Exchange Act [17 CFR
240.15g-2 through 15g-9] are collectively known as the ``penny stock
rules.'' See also Schedule 15G under the Exchange Act.
\193\ In addition, Rule 15g-1(a), (d), (e), and (f) exempt
certain other transactions from the disclosure requirements in Rules
15g-2 through 15g-6. Rule 15g-1(c) exempts transactions that meet
the requirements of Regulation D or that are exempt from the
registration requirements of the Securities Act pursuant to Section
4(a)(2). Rule 15g-1 also includes a provision the Commission can use
to exempt by order any other transactions or persons from the penny
stock rules as consistent with the public interest and the
protection of investors.
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In connection with the proposed amendments to the accredited
investor definition in Rule 501(a), we propose to amend Rule 15g-1(b)
to include a reference to proposed Rules 501(a)(9) and (a)(12).\194\ We
believe that, like the institutional accredited investors currently
within the scope of Rule 15g-1(b) as well as those that we propose to
add to the accredited investor definition in Rule 501(a)(1), entities
owning investments in excess of $5 million that are not formed for the
specific purpose of acquiring the securities being offered and family
offices are less in need of the protections provided by Rules 15g-2
through 15g-6.\195\ We believe that, consistent with the categories of
institutional accredited investors presently listed in Rule 15g-1(b),
entities within the scope of proposed Rule 501(a)(9), family offices,
and the other types of entities we propose to add to the accredited
investor definition generally: Invest in speculative equity securities
as part of an overall investment plan, have a good understanding of the
risks of investing in penny stocks, and have the ability to obtain and
evaluate independent information regarding these stocks.\196\
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\194\ We are also proposing a technical amendment to Rule 15g-
1(c) to update the reference to Section 4(2) of the Securities Act
to reflect the current numbering scheme in Section 4.
\195\ As discussed above, we are also proposing to amend a
number of the existing categories in the accredited investor
definition relating to institutional investors that fall within the
scope of the exemption in Rule 15g-1(b).
\196\ See Penny Stock Disclosure Rules, Release No. 34-29093
(Apr. 17, 1991) [56 FR 19165 (Apr. 25, 1991)] and Penny Stock
Disclosure Rules, Release No. 34-30608 (Apr. 20, 1992) [57 FR 18004
(Apr. 28, 1992)].
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Request for Comment
46. Should the Commission amend Rule 15g-1(b) to include a
reference to proposed Rule 501(a)(9)? Are there certain entities that
would fall within the scope of proposed Rule 501(a)(9) that have more
need for the disclosures required under Rules 15g-2 through 15g-6?
47. Should the Commission amend Rule 15g-1(b) to include a
reference to proposed Rule 501(a)(12)?
48. As discussed above, the Commission is proposing to expand the
list of entities that would qualify for accredited investor status
under Rule 501(a)(1). Should the entities that are proposed to be added
under Rule 501(a)(1) be included in the exemption set forth in Rule
15g-1(b)? Would certain of these entities have more need for the
disclosures required under Rules 15g-2 through 15g-6?
49. As discussed above, the Commission is proposing to codify a
longstanding staff position that limited liability companies that
satisfy the other requirements of the definition are eligible to
qualify as accredited investors under Rule 501(a)(3). Should these
limited liability companies continue to be included in the exemption
set forth in Rule 15g-1(b)? Do limited liability company investors have
more need for the disclosures required under Rules 15g-2 through 15g-6?
III. Additional Requests for Comment on the Accredited Investor
Definition
In the Concept Release, we requested comment on whether we should
revise the financial thresholds in the accredited investor definition.
Specifically, we requested comment on, among other things, three
recommendations that the Commission staff included in the 2015 Staff
Report: (1) Leaving the current income and net worth thresholds in
place, subject to investment limits; (2) creating new, additional
inflation-adjusted income and net worth thresholds that are not subject
to investment limits; or (3) indexing all financial thresholds for
inflation on a going-forward basis.\197\ Table 3 below provides an
overview of the feedback provided by commenters on the Concept Release
about each of the three recommendations.
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\197\ The comments on these recommendations received in response
to the 2015 Staff Report are described in Section II.A.4 of the
Concept Release. Following release of the 2015 Staff Report, the
Commission continued to receive recommendations about revising the
financial thresholds in the accredited investor definition from a
number of parties. In July 2016, the Advisory Committee on Small and
Emerging Companies recommended, among other things, that the
Commission not change the current financial thresholds in the
accredited investor definition except to adjust them, on a going-
forward basis, to reflect inflation. See 2016 ACSEC Recommendations.
The 2016, 2017, and 2018 Small Business Forum Reports all included a
recommendation that the Commission maintain the monetary thresholds
for accredited investors but did not include a recommendation for
future inflation adjustments. The 2019 Small Business Forum Report
included a recommendation that the Commission revise the dollar
amounts in the definition to scale for geography, lowering the
thresholds in states or regions with a lower cost of living.
Table 3--Responses to Requests for Comment on Financial Thresholds in
the Accredited Investor Definition
------------------------------------------------------------------------
Staff request for comment Responses from commenters
------------------------------------------------------------------------
Leave the current income and net worth --Several commenters opposed
thresholds in place, subject to subjecting the current
investment limits. thresholds to investment
limits.\198\
--Several commenters supported
making the net worth and
income requirements more
inclusive.\199\
Add new inflation-adjusted income and --Two commenters supported
net worth thresholds that are not raising the income and net
subject to investment limits. worth thresholds
immediately.\200\
--Several commenters opposed
raising the income and net
worth thresholds.\201\
Index all financial thresholds in the --Several commenters opposed
definition for inflation on a going- indexing financial thresholds
forward basis. to inflation.\202\
--Several commenters supported
indexing financial thresholds
to inflation going
forward.\203\
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[[Page 2593]]
In addition to comments received on the specific questions relating
to inflation adjustments, the Commission also received input from
commenters who questioned the correlation between wealth and financial
sophistication and were of the view that the income and net worth tests
fail to identify correctly those individuals who should be accredited
investors.\204\
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\198\ See J. Wallin Letter; 2019 SBIA Letter; ABA FR of Sec.
Comm. Letter; Sec. Reg. Comm. of N.Y.St. B.A. Letter; and CrowdCheck
Letter.
\199\ See letter from Logan B. dated June 24, 2019 (suggesting
that the thresholds be lowered); letter from Herwig Konings dated
June 24, 2019 (requesting the inclusion of more retail investors
without specifically recommending that the thresholds be lowered);
letter from J.C. dated July 10, 2019 (suggesting that the thresholds
be lowered); letter from Stephen R. Steciak dated August 4, 2019
(suggesting a dollar credit against the net worth requirement if the
investor was a college graduate or held a securities license);
letter from Barry Hicks dated September 16, 2019 (suggesting that
the thresholds be lowered); P. Rutledge Letter (suggesting that the
thresholds be lowered if certain assets were excluded from the net
worth definition); letter from Silicon Prairie Holdings dated
September 24, 2019 (suggesting that the thresholds be lowered);
letter from Luke Carriere dated September 24, 2019 (suggesting that
the thresholds be lowered); letter from Steven Richards dated
September 24, 2019 (suggesting that the thresholds be lowered); and
REDCO Letter (suggesting that the net worth threshold be lowered for
certain regions of the country).
\200\ See letter from Marc Steinberg dated August 5, 2019; and
letter from NASAA dated October 11, 2019 (``2019 NASAA Letter'').
\201\ See Wefunder Letter; ACA Letter; HFA Letter; Funding
Circle Letter; MLA Letter; J. Wallin Letter; Republic Letter; MFA
and AIMA Letter; EquityZen Letter; D. Burton Letter; CoinList
Letter; 2019 SBIA Letter; IPA Letter; Sec. Reg. Comm. of N.Y.St.
B.A. Letter; and CrowdCheck Letter.
\202\ See 2019 SBIA Letter; AngelList Letter; CCMC Letter; and
IPA Letter.
\203\ See Wefunder Letter; P. Rutledge Letter; CFA Institute
Letter; MFA and AIMA Letter (stating that indexing to inflation
would ``help to ensure that the thresholds have not been diluted
over time''); Consumer Federation Letter; EquityZen Letter; ICI
Letter; MA Secretary Letter; Davis Polk Letter; PIABA Letter; ADISA
Letter; Artivest Letter; letter from Elizabeth D. de Fontenay et al.
dated September 24, 2019 (stating that ``inflation undermines the
effectiveness of the safeguards built into the Accredited Investor
net-worth and income tests''); 2019 NASAA Letter; Sec. Reg. Comm. of
N.Y.St. B.A. Letter; CrowdCheck Letter; and 2019 Advisory Committee
Recommendation.
\204\ See, e.g., 2019 NASAA Letter; Consumer Federation Letter;
and 2014 Investor Advisory Committee Recommendation.
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We believe that the current wealth-based criteria are useful for
the identification of investors who do not require the protections
afforded by registration, even though we also believe they have
excluded investors who are financially sophisticated, such as those
with certain professional certifications and designations who do not
meet these criteria.\205\ Accordingly, we believe the use of financial
thresholds as one method of qualifying as an accredited investor is
appropriate. These financial thresholds have not been adjusted for
inflation since they were adopted.\206\ For example, the $5 million
asset test for certain entities, if adjusted for inflation since 1982
to 2019 dollars using the Consumer Price Index for All Urban Consumers
(``CPI-U'') published by the Bureau of Labor Statistics (``BLS''),
would result in a $13 million asset test. Similarly adjusting the
$200,000 income test for natural persons results in a $520,000
threshold, while adjusting the $300,000 joint income test for natural
persons from 1988 dollars to 2019 dollars would require a joint income
of $632,000. Table 4 below sets forth our estimation of the approximate
number and percentage of U.S. households that currently qualify as
accredited investors under the existing criteria and that qualified as
accredited investors in 1983 and 1989.\207\
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\205\ As described in the 2015 Staff Report, there are academic
studies that lend support to the theory that wealth is correlated to
financial sophistication. See Section IV.B of the 2015 Staff Report.
\206\ See Regulation D 1982 Adopting Release; Regulation D 1988
Adopting Release; and Regulation D 1989 Adopting Release.
\207\ For this analysis, we use the same methodology and
variable definitions as the 2015 Staff Report. The underlying
household data for this analysis was obtained from the Federal
Reserve Board's Survey of Consumer Finances (the ``SCF'') for 2016,
available at https://www.federalreserve.gov/econresdata/scf/scfindex.htm. The SCF is a triennial survey that provides insights
into household income and net worth, where the household is
considered to be the primary economic unit within a family. As of
the date of this release, the most recent SCF data is from the 2016
survey. The SCF employs weights to make the data representative of
the U.S. population. Thus, the 1983, 1989, and 2016 SCF and are
representative of the U.S. population in 1983 (approximately 83.9
million households), 1989 (approximately 92.8 million households),
and 2016 (approximately 125.9 million households), respectively.
The 2015 Staff Report used the definitions of income and net
worth from Jesse Bricker, Lisa J. Dettling, Alice Henriques, Joanne
W. Hsu, Kevin B. Moore, John Sabelhaus, Jeffrey Thompson, and
Richard A. Windle, Changes in U.S. Family Finances from 2010 to
2013: Evidence from the Survey of Consumer Finances, Federal Reserve
Bulletin, Vol. 100, No. 4 (2014).
We estimate households and not individuals due to data
limitations because the database underlying our analysis measures
wealth and income at the household level. It should be noted that in
the SCF database, income is reported at the household level. Similar
to the 2015 Staff Report, we do not attempt to differentiate income
based on marital status of the household because data on individual
income from all sources is not publicly available in the database.
As a result, accredited investor (household) estimates based on
individual income thresholds are likely to be overestimated and
would represent upper bounds. A household can have multiple family
members with independent sources of income that qualify them as
accredited investors based on income. We count them as one
accredited investor for each household, which implies we are also
likely underestimating the actual pool of accredited investors when
we provide household estimates. Consequently, the household
estimates we derive using the joint income threshold would represent
a lower bound for individuals qualifying on the basis of income. The
actual number of individuals that qualify as accredited investors on
an income basis (individual or joint) would, in all likelihood, lie
between the estimates that we derive for the individual income
threshold and the joint income threshold.
Table 4--Households Qualifying Under Existing Accredited Investor Criteria
[Standard errors are in parentheses]
--------------------------------------------------------------------------------------------------------------------------------------------------------
1983 1989 2019
-----------------------------------------------------------------------------------------------
Number of Qualifying Number of Qualifying Number of Qualifying
Basis for qualifying as accredited investor qualifying households as qualifying households as qualifying households as
households % of U.S. households % of U.S. households * % of U.S.
(millions) households (millions) households (millions) households *
--------------------------------------------------------------------------------------------------------------------------------------------------------
Individual income \208\ threshold ($200,000)............ 0.44 (0.10) 0.53 (0.12) 4.3 (0.4) 4.7 (0.5) 11.2 (0.3) 8.9 (0.2)
Joint income threshold \209\ ($300,000)................. N/A N/A 2.1 (0.3) 2.3 (0.4) 5.8 (0.2) 4.6 (0.2)
Net worth \210\ ($1,000,000)............................ 1.18 (0.17) 1.4 (0.20) 4.5 (1.0) 4.8 (1.1) 11.8 (0.3) 9.4 (0.2)
Overall number of qualifying households \211\........... 1.31 (0.18) 1.6 (0.21) 6.8 (1.0) 7.3 (1.1) 16.0 (0.3) 13.0 (0.2)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 2594]]
The data above provides an estimate of the overall pool of
qualifying households in the United States. It does not, however,
represent the actual number of accredited investors that do or would
invest in the Regulation D market or in other exempt offerings.\212\ In
addition, while we have information to estimate the number of some
categories of accredited investor entities, we lack comprehensive data
that will allow us to estimate the unique number of accredited
investors across all categories of entities under Rule 501(a).
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\208\ For purposes of this analysis, income is defined to
include wage income, business income, rent income, interest and
dividend income, pension income, social security income, income from
retirement accounts, transfers, and other income. According to the
SCF documentation, income data is collected for the year prior to
the year of the SCF while family balance sheet data covers the
status of the family at the time of the interview. Thus, we use
income data inflation-adjusted to 2016. Further, for comparability,
income data is adjusted for inflation by a factor of 1.05914411 from
2016 dollars to March 2019 dollars using Consumer Price Index for
All Urban Consumers (``CPI-U'') data from the BLS.
\209\ See supra note 207. Joint income was added to Rule 501(a)
in 1988.
\210\ For purposes of this analysis, net worth is defined as the
difference between household assets and household debt. Assets
include all financial assets (stocks, bonds, mutual funds, cash and
cash management accounts, retirement assets, life insurance, managed
assets like trusts and annuities, and other financial assets like
deferred compensation, royalties, futures, etc.) and non-financial
assets. Debt includes mortgage and home equity loans, lines of
credit, credit card debt, installment loans including vehicle loans,
margin loans, pension loans, and other debt (e.g., loans against
insurance). For comparability, we exclude the value of the
household's principal residence and any outstanding mortgages
associated with the principal residence from the 1983, 1989, and
2016 SCF. Further, for comparability, net worth data is adjusted for
inflation by a factor of 1.05914411 from 2016 dollars to March 2019
dollars using BLS CPI data.
\211\ The number of households qualifying under either the
income or net worth criterion is smaller than the sum of the number
of households qualifying under the income criterion and the number
of households qualifying under the net worth criterion because some
households may qualify under both criteria.
\212\ Form D data and other data available to us on private
placements do not allow us to estimate the number of unique
accredited investors participating in exempt offerings.
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Notwithstanding the significant increase in the number of investors
that qualify as accredited investors since 1982, we do not believe it
necessary or appropriate to modify the definition's financial
thresholds at this time.\213\ According to the U.S. Census Bureau, the
number of U.S. households has grown from approximately 83.9 million
households to approximately 127.6 million households from 1983 to 2018,
and the population of U.S. residents has grown from 236.4 million to an
estimated 327.1 million over this same period.\214\ Although it may be
argued that an investor with an income of $200,000 or a net worth of $1
million in 2019 is not as ``wealthy'' as such an investor would have
been in 1982, the income and net worth levels currently required in the
definition still exceed, by a large margin, the mean and median
household income and household net worth in all regions of the
country.\215\ Also, in 1982, the calculation of net worth included the
value of the primary residence. In 2011, the Commission amended the net
worth standard to exclude the value of the investor's primary
residence.\216\ Further, we believe that in evaluating the
effectiveness of the current thresholds, it is appropriate to consider
changes beyond the impact of inflation, such as changes over the years
in the availability of information and advances in technologies. Given
the rise of the internet, social media, and other forms of
communication, information about issuers and other participants in the
exempt markets is more readily available to a wide range of market
participants. Technologies such as powerful home computers and mobile
computing devices, as well software-based tools with which to evaluate
investment opportunities, were not available to investors at the time
the accredited investor definition was promulgated. In addition, we are
not aware of widespread problems or abuses associated with Regulation D
offerings to accredited investors that would indicate that an immediate
and/or significant adjustment to the rule's financial thresholds is
warranted.
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\213\ The Commission has previously considered whether to revise
the financial thresholds in the accredited investor definition. In
the 2007 Proposing Release, the Commission proposed to maintain the
thresholds but to apply an inflation adjustor every five years. See
2007 Proposing Release at 45126. However, the Commission took no
further action on the proposing release.
\214\ See the U.S. Census Bureau's time-series of U.S.
households, available at https://www2.census.gov/programs-surveys/demo/tables/families/time-series/households/ and the U.S. Census
Bureau's monthly estimates of the U.S. population, April 1, 1980 to
July 1, 1990, available at https://www2.census.gov/programs-surveys/popest/tables/1990-2000/national/totals/nat-total.txt and U.S.
Census Bureau's Quick Facts, available at https://www.census.gov/quickfacts/fact/table/US/PST045218.
\215\ The median household income in the U.S. in 2018 was
$61,937. See Household Income: 2018, American Community Survey
Briefs, available at https://www.census.gov/content/dam/Census/library/publications/2019/acs/acsbr18-01.pdf. The median (average)
net worth in the U.S. was $29,410 ($196,200) in 2016. See the U.S.
Census Bureau's Survey of Income and Program Participation (SIPP),
Wealth, Asset Ownership, & Debt of Households Detailed Tables: 2016,
available at https://www.census.gov/data/tables/2016/demo/wealth/wealth-asset-ownership.html. The reported net worth estimates
exclude the value of personal home equity from the net worth
calculations.
\216\ See Regulation D 2011 Adopting Release.
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We are also mindful that a significant reduction in the accredited
investor pool through an increase in the definition's financial
thresholds could have disruptive effects on the Regulation D market,
which, as noted above, plays a vital role in U.S. capital
formation.\217\ For example, a sharp decrease in the accredited
investor pool may result in a higher cost of capital for companies,
particularly companies in regions of the country with lower venture
capital activity who may rely on ``angel'' or other individual
investors as a primary source of funding.\218\ Placing limits on the
amount that a person may invest under the current income and net worth
thresholds could have similarly disruptive effects on the Regulation D
market.
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\217\ For example, substantially increasing the thresholds to,
for example, reflect inflation since they were adopted, would reduce
significantly the number of individuals that currently qualify as
accredited investors under those tests. Such an increase would
reduce the percentage of qualifying households from approximately
13.0% today to approximately 4.2%.
\218\ For example, Lindsey and Stein (2019) examined the effects
of changes in angel financing stemming from the 2011 Dodd-Frank
Act's exclusion of an investor's primary residence in determining an
accredited investor's net worth. They found that a larger reduction
in the pool of potential accredited investors negatively affects
firm entry and reduces employment levels at small entrants and that
relative wages for the startup sector decline. As the pool of
potential accredited investors was reduced, they found negative
affects to firm entry, reduced employment levels at small entrants,
and a decline in relative wages for the startup sector.
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Further, raising the financial thresholds from current levels may
have disparate impacts on certain investors. For example, certain
geographic areas of the United States, such as the Midwest and South,
have a lower cost of living compared to other geographic areas and
employees in those areas may be earning lower wages relative to other
areas and therefore be less likely to qualify as accredited investors
under the current financial thresholds. An increase in the financial
thresholds would exacerbate this current disparity and would be more
likely to result in the loss of accredited investor status for
investors in those geographic areas. Adjusting the thresholds upward
could curtail the ability of many financially sophisticated people in
certain parts of the country from investing in local companies, about
which they have first-hand knowledge.
Below we present information on median and mean income and net
worth of U.S. households in major U.S. geographic regions. The data
shows that household income and net worth tend
[[Page 2595]]
to be lower in the Midwest and South regions.
Table 5--U.S. Household Income and Net Worth, by Region \219\
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($ thousands) Northeast Midwest South West
----------------------------------------------------------------------------------------------------------------
Mean household income (before-tax).............. 136.5 102.0 100.0 108.5
Median household income (before-tax)............ 64.4 54.7 51.5 57.5
Mean household net worth........................ 851.3 658.8 636.9 873.7
Median household net worth...................... 154.5 103.2 87.0 114.3
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Moreover, increasing the total assets test to reflect inflation
could cause smaller entities that currently qualify as accredited
investors to no longer qualify. Such an immediate increase could be
highly disruptive for smaller entities, preventing them from accessing
an important segment of the private markets.
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\219\ The Federal Reserve Board's 2016 SCF Chartbook, available
at https://www.federalreserve.gov/econres/files/BulletinCharts.pdf,
at 28, 29, 64, and 65. The public version of the SCF database does
not provide information regarding geographical location of
households. As a result, we are unable to identify in which states
households that qualify as accredited investors are likely to be
concentrated. Unlike Table 4, in which we exclude the value of the
primary residence from net worth, Table 5 does not exclude the value
of the primary residence from the net worth of households. The
figures were adjusted for inflation to March 2019 dollars using BLS
CPI data.
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While we are not proposing to amend the financial thresholds in the
accredited investor definition at this time, we are requesting further
comment on possible approaches to adjusting these financial thresholds.
If the financial thresholds in the definition remain constant, the pool
of accredited investors would likely continue to expand as a result of
inflation. It is challenging to generate a precise forecast of how much
the pool of accredited investors will expand in the future,
particularly over longer time periods.\220\ We expect that the
Commission will continue to monitor the size of this pool as well as
the percentage and types of individuals from this pool who participate
in our private markets, including in connection with its quadrennial
review of the accredited investor definition required by the Dodd-Frank
Act.
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\220\ The proportion of households that meets the income or net
worth thresholds would depend on the evolution of nominal income
(i.e., income level affected by inflation and real growth,) and net
worth across different levels of income and net worth. With
inflation or real growth in the economy, the proportion of
households that meets these thresholds at their current levels is
expected to increase over time.
For example, to illustrate the effects of inflation, assuming,
among other things, no change in savings, we expect households with
a current net worth between approximately $985,000 and $999,999
would meet the net worth threshold if their assets grew by 1.51%,
the estimated annual rate of inflation between 2013 and 2018, over
one year. (To calculate this inflation rate, we use CPI-U data from
the BLS, available at https://www.bls.gov/regions/mid-atlantic/data/consumerpriceindexhistorical_us_table.htm.) This could increase the
proportion of households that meets the net worth threshold by 0.1
percentage points, to 9.5%. Similarly, we expect that individuals
with a current income between approximately $197,000 and $199,999,
to the extent they experienced one year of income growth equal to
the estimated annual rate of inflation between 2013 and 2018, to
meet the income threshold for individuals. This could increase the
proportion of individuals that meets the income threshold by 0.31
percentage points, to 9.21%. See also supra Table 4.
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As a result, the investor protections provided by the current
thresholds could erode over time due to inflation to the extent the
effects of such inflation on the pool of potential accredited investors
were not offset by other changes in the investing environment that
enhanced the ability of investors to analyze investment opportunities
and make informed investment decisions in private markets. Rather than
mandate a prospective adjustment for the effects of inflation, we
believe it would be more appropriate for the Commission to consider the
impact, if any, of inflation on the pool of accredited investors in
connection with its quadrennial review of the accredited investor
definition. Under this approach, the Commission could take into account
not just inflation but all developments with respect to private
investing as it considers the need for any changes in the accredited
investor definition. However, adjusting the financial thresholds, for
example, by indexing for inflation, could raise some of the concerns
discussed above or have other adverse ramifications on the Regulation D
market.
In addition to feedback on possible adjustments to the financial
thresholds in the definition, we are requesting further comment on
whether we should permit an investor, whether a natural person or an
entity, that is advised by a registered investment adviser or broker-
dealer to be considered an accredited investor. The 2017 Treasury
Report recommended that the Commission undertake amendments to the
accredited investor definition, including by broadening the definition
to include, among other things, any investor who is advised on the
merits of making a Regulation D investment by a fiduciary, such as an
SEC- or state-registered investment adviser. As noted in the Concept
Release, being advised by a financial professional has not been a
complete substitute historically for the protections of the Securities
Act registration requirements and, if applicable, the Investment
Company Act.\221\ Commenters on the Concept Release who addressed this
topic were generally supportive of expanding the accredited investor
definition in this manner,\222\ though other commenters were opposed to
or expressed concern regarding this approach.\223\ We are seeking
feedback on whether amending the accredited investor definition in this
manner would provide sufficient investor protections and whether
additional limitations on the types or amounts of investments or other
conditions may be appropriate if the Commission were to adopt such an
approach in expanding the accredited investor definition.
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\221\ See Concept Release at 30478.
\222\ See, e.g., IAA Letter, Artivest Letter, MarketPlus Letter,
EquityZen Letter, 2019 SBIA Letter, IPA Letter, BlackRock Letter,
and Wefunder Letter.
\223\ See, e.g., ICI Letter and PIABA Letter.
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Request for Comment
50. Should we maintain the current financial thresholds in the
definition of accredited investor and index the thresholds to inflation
on a going-forward basis? If so, what would be an appropriate interval
to index the thresholds to inflation? For example, should the
Commission consider whether adjustment for inflation is appropriate
every four years in connection with the Commission's quadrennial review
of the accredited investor definition required by the Dodd-Frank Act?
51. Should we make a one-time adjustment to increase the thresholds
to take into account some or all of the effects of inflation on the
pool of
[[Page 2596]]
potential accredited investors since adoption? What would be the
effects of any such change on investors and issuers? Should we also
index the thresholds to inflation on a going-forward basis? Should we
consider other approaches such as the recommendation in the 2015 Staff
Report to leave the current thresholds for natural persons in place but
subject them to investment limits? If so, what investment limits should
we consider? What would be the impact of such changes on investors and
on the ability of companies to raise capital, particularly small
businesses?
52. Should we increase the thresholds to take into account the
effects of inflation since adoption, but grandfather investors that
currently meet the accredited investor definition with respect to
existing investments?
53. Is there any evidence that investor protections provided by the
existing thresholds have eroded over time?
54. As noted above and in the Economic Analysis below, income
levels vary, sometimes substantially, in different geographic areas of
the country. Should we take into account income disparities that may be
attributable to different costs of living across the country in
establishing financial thresholds in the accredited investor
definition? If so, how should we categorize different geographic
regions for these purposes and how should we calculate income
differences that may be attributable to differences in cost of living?
For example, should we categorize the regions by state, by
county or parish, or by census tract? If we should instead use larger
regions, how should those be defined? How often would we need to
reconsider how the regions are defined?
If income disparities that may be due to local differences
in the cost of living were taken into account, would the financial
thresholds need to be adjusted for certain regions? How would we
determine which regions require adjustment? Similarly, how would we
determine which regions should maintain the current thresholds?
If these income disparities that may be due to differences
in the local cost of living were taken into account, should we use the
United States Office of Personnel Management's general schedule
locality areas? Should we use a different adjustment mechanism?
Should we consider any other changes to the accredited
investor definition to address the geographic disparity in the
proportion of the population that qualifies as accredited investors in
different regions of the country? If so, what types of changes would be
appropriate?
Would there be difficulties for investors to demonstrate,
and issuers to form a reasonable belief about, the varying financial
thresholds? How would we address any such difficulties?
55. Would an inflation adjustment on an on-going basis have a
disparate impact on certain types of investors, such as those in
particular geographic regions or those in specific age ranges?
56. Is there evidence that any fraud in the private markets is
driven or affected by the levels at which the accredited investor
definition is set, or that maintaining the current financial thresholds
would place investors at a greater risk of fraud?
57. Would providing for an inflation adjustment going forward have
an impact on the ability of companies to raise capital, particularly
small businesses? Would an inflation adjustment going forward have a
disparate impact on certain small businesses, such as those in
particular geographic regions with lower venture capital activity?
58. Under the current definition, the value of a person's primary
residence is excluded from the net worth calculation.\224\ Should the
Commission consider any changes to the rules implementing this
requirement? Are there other assets or liabilities that should be
excluded from or included in the calculation? Should we consider
excluding all or a portion of an individual's retirement accounts when
calculating net worth, similar to the exclusion for an individual's
primary residence? If so, what percentage of an individual's retirement
account should be excluded?
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\224\ Section 413(a) of the Dodd-Frank Act excluded the value of
a person's primary residence from the net worth calculation and
directed the Commission to adjust similarly any accredited investor
net worth standard in its Securities Act rules. In 2011, the
Commission revised Rules 215 and 501 to exclude any positive equity
that individuals have in their primary residences. See Regulation D
2011 Adopting Release. The revised calculation requires that any
excess of indebtedness secured by the primary residence over the
estimated fair market value of the residence be considered a
liability for purposes of determining accredited investor status on
the basis of net worth. The Commission also added a 60-day lookback
period to prevent investors from artificially inflating their net
worth by incurring incremental indebtedness secured by their primary
residence, thereby effectively converting their home equity into
cash or other assets that would be included in the net worth
calculation.
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59. If we index the financial thresholds, is CPI-U the appropriate
inflation adjustor? 17 CFR 275.205-3(e) under the Advisers Act and
certain other Commission rules use as an inflation adjustor the
Personal Consumption Expenditures Chain-Type Price Index (``PCE'') (or
any successor index thereto), as published by the United States
Department of Commerce, which is an indicator of inflation in the
prices for goods and services paid by persons living in the United
States.\225\ Should we use PCE instead of CPI-U? Is indexing for
inflation the appropriate benchmark? Are there more appropriate
benchmarks?
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\225\ See https://www.bea.gov/data/personal-consumption-expenditures-price-index.
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60. If we were to permit an investor advised by a registered
investment adviser or broker-dealer to be deemed an accredited
investor, under what circumstances would that registered financial
professional be likely to recommend investing in a Regulation D
offering? What types of investors would be likely to receive a
recommendation from that registered financial professional to invest in
a Regulation D offering?
61. If an investor is to be considered an accredited investor by
virtue of being advised by a registered investment adviser or broker-
dealer, should we consider additional investor protections? For
example, should such financial professionals have to eliminate any
conflicts of interest related to such advice for its advice to render
an investor an accredited investor or should such a financial
professional have to mitigate such conflicts of interest in a
particular way? Should such financial professionals have to conduct any
different due diligence before advising the investor on such
investments? Should there be limits on the types or amounts of
investments that such an investor could make under these circumstances?
IV. Proposed Amendment to the Qualified Institutional Buyer Definition
Rule 144A provides a non-exclusive safe harbor exemption from the
registration requirements of the Securities Act for resales to
qualified institutional buyers of certain restricted securities. Any
person, other than the issuer or a dealer, who offers or sells
securities in compliance with Rule 144A is deemed not to be engaged in
a distribution of the securities and therefore not an underwriter of
the securities within the meaning of Section 2(a)(11) of the Securities
Act, such that the Section 4(a)(1) exemption is available for the
resales of the securities.\226\ When originally proposing to define a
``qualified institutional buyer,'' the Commission noted that it was
``seeking to identify a class of
[[Page 2597]]
investors that can be conclusively assumed to be sophisticated and in
little need of the protection afforded by the Securities Act's
registration provisions.'' \227\
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\226\ Rule 144A(b).
\227\ See Resale of Restricted Securities; Changes to Method of
Determining Holding Period of Restricted Securities Under Rules 144
and 145, Release No. 33-6806 (Oct. 25, 1988) [53 FR 44016 (Nov. 1,
1988)].
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With the exception of registered dealers, a qualified institutional
buyer must in the aggregate own and invest on a discretionary basis at
least $100 million in securities of issuers that are not affiliated
with that qualified institutional buyer.\228\ Under Rule
144A(a)(1)(vi), banks and other specified financial institutions are
subject to an additional minimum audited net worth requirement of $25
million.\229\ Rule 144A(a)(1)(i) specifies the types of institutions
that are eligible for qualified institutional buyer status if they meet
this $100 million in securities owned and invested threshold, which
include insurance companies; registered investment companies; SBICs;
employee benefit plans established and maintained by a state, its
political subdivisions, or any agency or instrumentality of a state or
its political subdivisions; employee benefit plans within the meaning
of Title I of the Employee Retirement Income Security Act (ERISA) of
1974; trust funds whose trustee is a bank or trust company and whose
participants are employee benefit plans within the scope of Rule
144A(a)(1)(i)(D) or (E), excluding trust funds that include individual
retirement accounts or H.R. 10 plans as participants; business
development companies; and registered investment advisers.\230\ In
addition, Rule 144A(a)(1)(i)(H) sets forth the following types of
eligible entities:
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\228\ Rule 144A(a)(1)(i). A registered dealer is a qualified
institutional buyer if it owns and invests in the aggregate at least
$10 million of securities of non-affiliated issuers on a
discretionary basis or if it is acting in a riskless principal
transaction on behalf of a qualified institutional buyer. Rules
144A(a)(1)(ii) and (iii).
\229\ Rule 144A(a)(1)(vi).
\230\ Rule 144A(a)(1)(i)(A)-(G) and (I).
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Organizations described in Section 501(c)(3) of the
Internal Revenue Code;
Corporations (other than a bank as defined in Section
3(a)(2) of the Securities Act or a savings and loan association or
other institution referenced in Section 3(a)(5)(A) of the Securities
Act or a foreign bank or savings and loan association or equivalent
institution);
Partnerships; and
Massachusetts or similar business trusts.
A number of commenters on the Concept Release recommended that the
Commission expand the list of entities that are eligible for qualified
institutional buyer status. One commenter recommended that the
Commission revise the qualified institutional buyer definition to
include any entity.\231\ Some commenters urged the Commission to expand
the qualified institutional buyer definition to encompass additional
state and local governmental entities and organizations \232\ or non-
U.S. entities such as sovereign wealth funds and non-U.S. pension funds
that are substantially equivalent to the entities that currently
qualify for qualified institutional buyer status.\233\ A number of
commenters recommended that the Commission permit bank-maintained
collective investment trusts that include certain H.R. 10 plans to
qualify as qualified institutional buyers \234\ and/or allow collective
investment trusts to qualify using the ``family of investment
companies'' test available to registered investment companies under
Rule 144A(a)(1)(iv).\235\
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\231\ See PFM Letter.
\232\ See letter from San Bernardino County Treasury dated
September 24, 2019; letter from South Dakota Investment Counsel
dated September 24, 2019; and CMTA Letter.
\233\ See letter from Franklin Resources, Inc. dated September
24, 2019 (``Franklin Templeton Letter'') and IAA Letter.
\234\ See letter from Wilmington Trust, N.A. dated September 24,
2019; BlackRock Letter (also recommending that bank maintained
common trust funds that include H.R. 10 plans similarly qualify);
letter from Coalition of Collective Investment Trusts dated
September 24, 2019; letter from Fidelity Investments dated September
24, 2019; Franklin Templeton Letter; and letter from American
Bankers Association dated September 24, 2019 (``Am. Bankers Assn.
Letter''). A number of these commenters noted that an H.R. 10 plan
(also known as a ``Keough plan'') may qualify as a qualified
institutional buyer in its own right under Rule 144A(a)(1)(i)(E) if
it meets the applicable conditions but that a collective investment
trust that includes such an H.R. 10 plan as a participant would not
be eligible for qualified institutional buyer status under Rule
144A(a)(1)(i)(F).
\235\ See SIFMA Letter; Franklin Templeton Letter; Shartsis
Friese Letter; and Am. Bankers Assn. Letter (also recommending that
bank maintained common trust funds qualify under the same test).
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One commenter urged the Commission to clarify that the term
``similar business trust'' under Rule 144A(a)(1)(i)(H) includes central
managed trusts that otherwise qualify under the definition which are
managed by a foreign or domestic bank or a professional investment
manager that itself qualifies as a qualified institutional buyer.\236\
Another commenter recommended that the Commission adopt a calculation
method based on fair market value, rather than cost basis, in
determining the aggregate value of securities owned and invested for
purposes of Rule 144A(a)(3).\237\ Two commenters stated that the
Commission should consolidate the qualified institutional buyer
definition with other definitions.\238\
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\236\ See ICI Letter.
\237\ See Shartsis Friese Letter.
\238\ See letter from CompliGlobe Ltd. dated September 24, 2019
(recommending that the Commission consolidate the definitions of
qualified purchaser, qualified investor, qualified institutional
buyer, major U.S. institutional investor, and U.S. institutional
investor into a single new definition) and letter from William J.
Williams, Jr. dated September 25, 2019 (recommending that the
Commission adopt a consolidated and simplified version of Rules 506,
144, and 144A that would limit sales to eligible purchasers).
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In light of these concerns and to avoid inconsistencies between the
entity types that are eligible for accredited investor status and
qualified institutional buyer status, we propose to expand the
qualified institutional buyer definition by making conforming changes
to Rule 144A(a)(1)(i)(C) and the list of entities in Rule
144A(a)(1)(i)(H) to correspond to the proposed amendments to Rule
501(a)(1) and Rule 501(a)(3). Specifically, we propose to add RBICs to
Rule 144A(a)(1)(i)(C) and limited liability companies to Rule
144A(a)(1)(i)(H). Further, to ensure that entities that qualify for
accredited investor status may also qualify for qualified institutional
buyer status when they meet the $100 million in securities owned and
invested threshold in Rule 144A(a)(1)(i), we propose to add new
paragraph (J) to Rule 144A(a)(1)(i) that would permit institutional
accredited investors under Rule 501(a), of an entity type not already
included in paragraphs 144A(a)(1)(i)(A) through (I) or 144A(a)(1)(ii)
through (vi), to qualify as qualified institutional buyers when they
satisfy the $100 million threshold.\239\ This new category in the
qualified institutional buyer definition would encompass the proposed
new category in the accredited investor definition for entities owning
investments in excess of $5 million that are not formed for the
specific purpose of acquiring the securities being offered under
Regulation D,\240\ as well as any other entities that may be added to
the accredited investor definition in the future, but such entities
would also have to meet the $100 million threshold in order to be
qualified institutional buyers under Rule 144A.
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\239\ Because proposed Rule 144A(a)(1)(i)(J) would cover
entities not included in paragraphs (A) through (I), a bank or other
financial institution specified in those paragraphs would continue
to be required to satisfy the net worth test in Rule 144A(a)(vi).
\240\ Proposed Rule 501(a)(9).
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[[Page 2598]]
We believe that these proposed changes would expand the qualified
institutional buyer definition to encompass all of the entity types
suggested by commenters on the Concept Release, so long as these
entities meet the $100 million threshold in Rule 144A(a)(1)(i).\241\
The $100 million threshold for these entities to qualify for qualified
institutional buyer status should ensure that these entities have the
financial sophistication and access to resources such that they do not
need the protections of registration under the Securities Act. Eligible
purchasers under Rule 144A(a)(1)(i) would continue to include entities
formed solely for the purpose of acquiring restricted securities under
Rule 144A, provided that they satisfy the test for qualified
institutional buyer status.\242\
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\241\ For example, proposed Rule 144A(a)(1)(i)(J) would
encompass bank-maintained collective investment trusts that include
as participants individual retirement accounts or H.R. 10 plans that
are currently excluded from the qualified institutional buyer
definition pursuant to Rule 144A(a)(1)(i)(F), so long as the
collective investment trust satisfies the $100 million threshold.
\242\ This is in contrast to the proposed amendment to the
accredited investor definition in Rule 501(a)(3), which would
continue to require that the entity not be formed for the specific
purpose of acquiring the securities offered.
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Request for Comment
62. Should Rule 144A(a)(1)(i)(C) be amended to include RBICs in a
manner consistent with the proposed amendments to Rule 501(a)(1)?
Should Rule 144A(a)(1)(i)(H) be amended to include limited liability
companies in a manner consistent with Rule 501(a)(3)? Rather than, or
in addition to, amending Rule 144A in this manner, should we add other
types of entities to those currently in Rule 144A(a)(1)(i)? Are there
any categories of entities included in the proposed amendment to Rule
501(a) that should not be included in the definition of qualified
institutional buyer under Rule 144A?
63. Should we add a new paragraph (J) to Rule 144A(a)(1)(i) to
expand the list of entities eligible to be qualified institutional
buyers to include institutional accredited investors under Rule 501(a)
that meet the $100 million in securities owned and invested threshold
and that are an entity type not already included in paragraphs
144A(a)(1)(i)(A) through (I) or 144A(a)(1)(ii) through (vi)? Are there
any types of entities that should be included under new paragraph (J)
that would be excluded because of the limitation that these additional
entity types may not include entities otherwise listed in existing
paragraphs (a)(1)(i) through (vi) of Rule 144A? To the extent that
there is overlap between the types of entities listed in the accredited
investor definition and those listed in the qualified institutional
buyer definition, would adding new paragraph (J) render existing
paragraphs (A) through (I) under Rule 144A(a)(1)(i) unnecessary?
64. Are there certain types of entities that are less likely to
have experience in the private resale market for restricted securities
and may have more need for the protections afforded by the Securities
Act's registration provisions? Are there concerns about amending the
definition of ``qualified institutional buyer'' to encompass an
expanded list of entities in Rule 144A(a)(1)(i) that meet the $100
million in securities owned and invested threshold?
65. If we were to expand the definition of qualified institutional
buyer in this manner, would there be a greater likelihood of restricted
securities sold under Rule 144A flowing into the public market? If so,
should we consider additional modifications to Rule 144A to address
this possibility?
V. Implications for Other Contexts
In addition to its central role in offerings conducted under
Regulation D, the accredited investor definition plays an important
role in other areas of federal securities law and in other contexts. To
assist the Commission in more fully understanding the implications of
amending the accredited investor definition, we are soliciting comment
on the implications of the proposed amendments for these other
contexts.
An issuer that is not a bank, a savings and loan holding company,
or a bank holding company must register a class of equity securities
under Exchange Act Section 12(g) and become an reporting company under
the Exchange Act if, on the last day of its fiscal year, it has total
assets of more than $10 million and the class of equity securities is
held of record by either (i) 2,000 or more persons, or (ii) 500 or more
persons who are not accredited investors as defined in Rule
501(a).\243\ Under existing rules, a non-reporting issuer must analyze
at its fiscal year end whether its total assets and the number of its
record holders meet these thresholds in determining whether it must
commence reporting under the Exchange Act. For Section 12(g) purposes,
the determination of accredited investor status must be made as of the
last day of the issuer's most recent fiscal year rather than at the
time of the sale of the securities.\244\ As stated above, the
accredited investor definition in Rule 501(a) includes a reasonable
belief standard, such that any person who comes within one or more of
the categories in the definition, or whom the issuer reasonably
believes comes within such category or categories, is deemed to be an
accredited investor.\245\ To the extent that non-reporting issuers sell
securities to individuals or entities that qualify for accredited
investor status under the proposed new categories in the definition,
new issues and complexities in establishing a reasonable belief as to
whether these individuals or entities are accredited investors as of a
fiscal year end may be introduced to the Section 12(g) year-end
analysis. Depending on the circumstances, this could result in complex
and time-consuming determinations by issuers as of a subsequent fiscal
year end if they sell securities to such individuals or entities. On
the other hand, these issuers may be able to remain under the Section
12(g) thresholds and avoid having to register a class of equity
securities under Section 12(g) for a longer period if they are able to
sell securities to an expanded pool of accredited investors and to
fewer non-accredited investors.
---------------------------------------------------------------------------
\243\ 15 U.S.C. 78l(g) and 17 CFR 240.12g-1 under the Exchange
Act (``Rule 12g-1''). See Changes to Exchange Act Registration
Requirements to Implement Title V and Title VI of the JOBS Act,
Release No. 33-10075 (May 3, 2016) [81 FR 28689 (May 10, 2016)]
(``Changes to Exchange Act Registration Requirements Release'').
\244\ Rule 12g-1(b)(1) under the Exchange Act.
\245\ Whether an issuer has a reasonable belief depends on the
particular facts and circumstances of the determination.
---------------------------------------------------------------------------
Regulation A limits the amount of securities that a person who is
not an accredited investor can purchase in an offering conducted under
Tier 2 of Regulation A when the issuer's securities are not listed on a
national securities exchange to no more than 10 percent of the greater
of annual income or net worth (for natural persons), or 10 percent of
the greater of annual revenue or net assets at fiscal year-end (for
entities).\246\ As a result of the proposed amendments to the
accredited investor definition, a wider pool of accredited investors
would not be subject to these investment limits applicable to non-
accredited investors, which could lead to more investor interest in
Tier 2 offerings under Regulation A.
---------------------------------------------------------------------------
\246\ See 17 CFR 230.251(d)(2)(i)(C).
---------------------------------------------------------------------------
In addition, some states use the accredited investor definition to
determine whether investment advisers to certain private funds must be
[[Page 2599]]
registered with the state \247\ or incorporate the definition in a
range of other contexts.\248\ Further, under Rule 504 of Regulation D,
issuers are permitted to use general solicitation or general
advertising to offer and sell securities when the offers and sales are
made (i) pursuant to state law exemptions from registration that permit
general solicitation and general advertising and (ii) sales are made
only to accredited investors as defined in Rule 501(a).\249\
---------------------------------------------------------------------------
\247\ See, e.g., Final Order Granting Exemption From the
Registration Requirements for Investment Advisers to Private Funds
and Their Investment Adviser Representatives, Wisconsin Department
of Financial Institutions, Division of Securities (Feb. 17, 2012);
Certificate Exemption for Investment Advisers to Private Funds, Cal.
Code Regs. Title 10 Sec. 260.204.9; and Sixth Transition Order
administering the Michigan Uniform Securities Act, State of Michigan
Department of Energy, Labor & Economic Growth, Office of Financial
and Insurance Regulation (Mar. 11, 2011).
\248\ See, e.g., Cal. Gov't Code Sec. 64111 (government
finance); Cal. Fin. Code Sec. 22064 (finance lending); Fla. Stat.
Sec. Sec. 494.001 and 494.00115 (mortgage lending); Tex. Ins. Code
Sec. 1111A.002 (insurance); and Conn. Gen. Stat. Sec. 36a-2 (2014)
(financial institution regulation).
\249\ Rule 504(b)(1)(iii).
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Finally, any changes to the accredited investor definition may have
an impact on the use of the Rule 506(c) exemption, which requires
issuers to take reasonable steps to verify the accredited investor
status of purchasers in the offering. To the extent that it may be
difficult for issuers to comply with the verification requirement in
Rule 506(c) with respect to new or modified categories of accredited
investors, issuers may be reluctant to, or determine not to, sell
securities to these investors in Rule 506(c) offerings. Conversely, to
the extent that the verification requirement presents fewer
difficulties for new or modified categories of accredited investors,
for example, natural persons with certain professional certifications
or designations that are more readily verifiable, issuers may be more
willing to sell securities in Rule 506(c) offerings to these investors.
Request for Comment
66. Would the proposed new categories of accredited investors and
the proposed modifications to the existing standards present issues for
non-reporting issuers in determining whether individuals and entities
that meet the accredited investor definition at the time of purchase
continue to be accredited investors as of the end of a fiscal year for
the purposes of Exchange Act Rule 12g-1?
67. Would expanding the accredited investor definition to encompass
the proposed new categories of accredited investors, such as persons
with certain professional certifications or designations or
knowledgeable employees of private funds, raise concerns under state
law provisions that incorporate the Rule 501(a) accredited investor
definition? If so, what are those concerns?
68. Would the proposed amendments to the accredited investor
definition give rise to issues under Rule 504 when issuers engage in
general solicitation or general advertising to offer and sell
securities pursuant to state law exemptions from registration that
permit general solicitation and general advertising when sales are made
only to accredited investors? If so, what are those issues?
69. Would there be concerns about meeting the verification
requirement in Rule 506(c) with respect to the proposed new categories
of accredited investors or the modifications to the existing categories
in the definition? If so, what are those concerns? Would amending the
accredited investor definition in this manner make it more likely or
less likely that an issuer would conduct a Rule 506(c) offering?
VI. General Request for Comment
We request and encourage any interested person to submit comments
regarding the proposed rule amendments, specific issues discussed in
this release, and other matters that may have an effect on the proposed
rule amendments. With regard to any comments, we note that such
comments are of particular assistance to our rulemaking initiative if
accompanied by supporting data and analysis of the issues addressed in
those comments.
VII. Economic Analysis
A. Introduction
The Commission is proposing to amend the ``accredited investor''
definition in Rule 501(a) of Regulation D by: (1) Adding new categories
in the definition that would permit natural persons to qualify as
accredited investors based on certain professional certifications or
designations or other credentials, or with respect to investments in a
private fund, as a ``knowledgeable employee'' of the private fund; (2)
adding certain entity types to the current list of entities that may
qualify as accredited investors and a new category for any entity with
``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; (3) adding
family offices with at least $5 million in assets under management and
their family clients to the definition; (4) adding the term ``spousal
equivalent'' to the definition, so that spousal equivalents may pool
their finances for the purpose of qualifying as accredited investors;
and (5) codifying certain staff interpretive positions that relate to
the accredited investor definition. The Commission is also proposing to
amend the definition of ``qualified institutional buyer'' in Rule 144A
to expand the list of entities that are eligible to qualify as
qualified institutional buyers.
We are attentive to the costs imposed by and the benefits obtained
from the proposed amendments. Section 2(b) of the Securities Act \250\
and Section 3(f) of the Exchange Act \251\ require us, when engaging in
rulemaking that requires us to consider or determine whether an action
is necessary or appropriate in the public interest, to consider, in
addition to the protection of investors, whether the action will
promote efficiency, competition, and capital formation. Additionally,
Section 23(a)(2) of the Exchange Act \252\ requires us, when making
rules or regulations under the Exchange Act, to consider, among other
matters, the impact that any such rule or regulation would have on
competition and states that the Commission shall not adopt any such
rule or regulation which would impose a burden on competition that is
not necessary or appropriate in furtherance of the Exchange Act.
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\250\ 15 U.S.C. 77b(b).
\251\ 15 U.S.C. 78c(f).
\252\ 17 U.S.C. 78w(a)(2).
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The discussion below addresses the potential economic effects of
the proposed amendments, including the likely benefits and costs, as
well as the likely effects on efficiency, competition, and capital
formation. Where possible, we have attempted to quantify the benefits,
costs, and effects on efficiency, competition, and capital formation
expected to result from the proposed amendments. In many cases,
however, we are unable to quantify the economic effects because we lack
the information necessary to derive a reasonable estimate. For example,
we are unable to quantify, with precision, the costs to issuers and
investors of verifying an investor's accredited investor status and the
potential capital raising and compliance cost savings that may arise
from the proposed amendments to the accredited investor definition.
B. Broad Economic Effects
Overall, because the accredited investor definition is an important
[[Page 2600]]
component of several exemptions from registration, including Rules
506(b) and 506(c) of Regulation D, we expect that the proposed
amendments, by expanding the pool of accredited investors, would
improve the ability of issuers to raise capital in the exempt markets
and reduce competition among issuers for investors, thus reducing the
cost of capital. Further, the proposed amendments would permit issuers
to engage in test-the-waters communications in registered offerings
with a larger set of investors as a result of changes to the definition
of institutional accredited investors and qualified institutional
buyers. Similarly, the proposed amendments to the qualified
institutional buyer definition in Rule 144A would increase the number
of entities that qualify for this status, thus improving the ability of
issuers to raise capital and enhancing competition among investors in
this market.\253\
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\253\ Although Rule 144A is a non-exclusive safe harbor for
resale transactions, market participants have used Rule 144A since
its adoption in 1990 to facilitate capital raising by issuers. See,
e.g., Eliminating the Prohibition Against General Solicitation and
General Advertising in Rule 506 and Rule 144A Offerings, Release No.
33-9415 (July 10, 2013) [78 FR 44771 (July 24, 2013)].
---------------------------------------------------------------------------
The proposed amendments also would impact investors, permitting
investors with different attributes of financial sophistication to
participate in investment opportunities that are often not available to
non-accredited investors, such as investments in issuers that are not
Exchange Act reporting companies, and offerings by certain private
equity funds, venture capital (VC) funds, and hedge funds, which are
frequently offered under Rule 506.\254\ Additionally, accredited
investors are not subject to investment limits in offerings made under
Tier 2 of Regulation A. Thus, expanding the definition of accredited
investor would permit additional investors to participate in these
offerings at higher amounts, subject to the $50 million offering limit.
---------------------------------------------------------------------------
\254\ See supra Section II.A.
---------------------------------------------------------------------------
The accredited investor concept in Regulation D was designed to
identify--with bright-line standards--a category of investors who do
not need the protections of registration under the Securities Act.
The accredited investor definition uses income and net worth
thresholds to identify natural persons as accredited investors. The
Commission established the $200,000 individual income and $1 million
net worth threshold in 1982 and the $300,000 joint income threshold in
1988 and has not updated them since, with the exception of amending the
net worth standard to exclude the value of the investor's primary
residence in 2011. According to data from the SCF, we estimate the
number of U.S. households that qualify as accredited investors has
grown from being approximately 2% of the population of U.S. households
in 1983 to 13% in 2019 as a result of inflation.\255\
---------------------------------------------------------------------------
\255\ See https://www.federalreserve.gov/econresdata/scf/scfindex.htm. For this analysis, we use the same methodology and
variable definitions as Table 4, and we exclude the value of a
household's primary residence when measuring net worth. See supra
note 207. We estimate the number of U.S. households, rather than
individuals, that qualify as accredited investors due to data
limitations because the database underlying our analysis measures
wealth and income at the household level. See supra Section III.
---------------------------------------------------------------------------
Regulation D also designates certain entities as accredited
investors. Some entities, including but not limited to banks, savings
and loan associations, registered broker-dealers, insurance companies,
and investment companies registered under the Investment Company Act
qualify as accredited investors based on their status alone. Other
entities may qualify as accredited investors based on a combination of
their status and the amount of their total assets.
While the effects of inflation have expanded the pool of accredited
investors, we are not aware from our enforcement experience or
otherwise of disproportionate fraud in this expanded space.
We are mindful that it is difficult to reach rigorous conclusions
about the typical magnitude of investor gains and losses in exempt
offerings. Therefore, it is difficult to determine definitively how the
benefits to accredited investors of expanded access to the exempt
market compare to the loss of protections provided by registration.
While having an expanded set of investment opportunities in private
markets can potentially help investors to make more efficient
investment decisions, other factors--such as information asymmetry,
illiquidity, and prevailing market practices--can nevertheless limit
investors' opportunity set for private markets. For example, as
discussed below, given the presumed financial sophistication of
accredited investors, issuers may rely on Rule 506(b) and Rule 506(c)
to offer securities on an unregistered basis to accredited investors
without providing additional disclosure to those investors.
The proposed amendments could increase the size and alter the
composition of the pool of accredited investors by providing additional
measures of financial sophistication (e.g., professional certifications
for individuals and an investments-owned threshold for entities) to
qualify for accredited investor status. If many individuals that would
qualify as accredited investors under the proposed amendments already
meet the income and wealth thresholds in the current accredited
investor definition, then the impact of the change on the pool of
individuals that qualify as accredited investors could be limited.
However, for entities, we anticipate that the impact of the proposed
amendments could be more significant, as we are proposing to amend the
accredited investor definition to include a broad range of entities
that are not covered under the current definition. Since we believe
family offices have generally qualified as accredited investors under
the existing definition, we expect that the effect of the amendments on
them would be much smaller than on other entities.
We anticipate that the additional investors we propose to designate
as accredited investors would have the resources and financial
sophistication to assess private investment opportunities, despite the
fact that these investments may have unique risk profiles and limited
disclosure requirements. For example, investors in Regulation D
offerings can be subject to investment risks not associated with
registered offerings because (i) some securities law liability
provisions do not apply to private offerings, (ii) issuers of
securities in these offerings generally are not required to provide
information comparable to that included in a registration statement,
and (iii) Commission staff does not review any information that may be
provided to investors in these offerings.\256\
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\256\ See 2015 Staff Report.
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Such risks are mitigated for accredited investors that participate
in Regulation A offerings because they have access to information
comparable to that accompanying registered offerings--e.g., publicly
available offering circulars on Form 1-A (for both Tier 1 and Tier 2
offerings), ongoing reports on an annual and semiannual basis (Tier 2
offerings), and additional requirements for interim current event
updates (Tier 2 offerings). Additionally, Commission staff reviews
Forms 1-A and the test-the-waters materials that issuers file in
connection with Regulation A offerings.
Generally, we believe any additional risk of accredited investors
experiencing harm in the capital markets as a result of the proposed
amendments likely would be limited because the proposed amendments are
intended to more
[[Page 2601]]
effectively identify individuals and entities that do not need the
protections rendered by registration under the Securities Act.
We believe the proposed amendments would improve capital formation
by providing issuers with an expanded pool of accredited investors and
additional avenues--in certain circumstances--to verify an investor's
accredited investor status, while likely having a minimal impact on
issuers' compliance costs. In 2018, the estimated amount of capital
reported as being raised in Rule 506 offerings was $1.7 trillion,\257\
which was larger than the $1.4 trillion raised in registered
offerings.\258\ As private capital markets have grown, the vast
majority of the capital that has been raised in unregistered offerings
under Regulation D has been through investment by accredited investors.
For example, though securities sold in offerings conducted pursuant to
Rule 506(b) are permitted to be purchased by up to 35 non-accredited
investors who are sophisticated, we estimate that, from 2013 to 2018,
only 6% of the offerings conducted under Rule 506(b) included non-
accredited investor purchasers.\259\
---------------------------------------------------------------------------
\257\ See Concept Release at 30466.
\258\ See id. at 30465.
\259\ DERA staff analysis is based on Form D filings from 2013
to 2018. These estimates are based on the reported ``total amount
sold'' at the time of the original filing--required within 15 days
of the first sale--as well as any additional capital raised and
reported in amended filings. The data likely underreport the actual
amount sold due to two factors. First, underreporting could occur in
all years because Regulation D filings can be made prior to the
completion of the offering, and amendments to reflect additional
amounts sold generally are not required if the offering is completed
within one year and the amount sold does not exceed the original
offering size by more than 10%. Second, Rule 503 requires the filing
of a notice on Form D, but filing a Form D is not a condition to
claiming a Regulation D safe harbor or exemption. Hence, it is
possible that some issuers do not file a Form D for offerings
relying on Regulation D. Finally, in their annual amendments, some
funds appear to report net asset values for total amount sold under
the offering. Net asset values could reflect fund performance as
well as new investment into, and redemptions from, the fund. For
these reasons, based on Form D data, it is not possible to
distinguish between the two impacts.
---------------------------------------------------------------------------
By increasing potential access to private markets and providing
issuers with additional tests for accredited investor status that are
objective and therefore readily verifiable (e.g., professional
certifications and investment tests), the proposed amendments may make
unregistered offerings more attractive to certain issuers and
particularly facilitate small business capital formation. For example,
while the aggregate amount of capital raised through Rule 506 offerings
in 2018 ($1.7 trillion) is large, the median offering size was only
$1.7 million, indicating that offerings in the Regulation D market
typically involve relatively small issues, which is consistent with
these offerings being undertaken by smaller and growth-stage firms.
Unregistered offerings also can be important for these issuers, as a
significant share of businesses that establish new funding
relationships continue to experience unmet credit needs.\260\ According
to one survey, approximately 64% of small businesses relied on personal
or family savings, compared to 0.5% receiving venture capital.\261\ In
addition, small businesses owned by underrepresented minorities faced
significantly higher hurdles in obtaining external financing, which
suggests that these businesses may particularly benefit from amendments
intended to facilitate private market capital raising.\262\ Similarly,
businesses located in states or regions with a lower cost of living may
uniquely benefit from the proposed amendments as the pool of accredited
investors may be smaller in such states or regions. Recent research has
examined the importance of the pool of accredited investors for the
entry of new businesses and employment and finds that geographic areas
experiencing a larger reduction in the number of potential accredited
investors experienced negative effects on new firm entry and employment
levels at small entrants.\263\
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\260\ See 2015 Staff Report.
\261\ See 2019 Kauffman Foundation Access to Capital for
Entrepreneurs: Removing Barriers, available at https://www.kauffman.org/-/media/kauffman_org/entrepreneurship-landing-page/capital-access/capitalreport_042519.pdf. The study relies on the
data from the 2016 Annual Survey of Entrepreneurs, released in
August 2018.
\262\ See id.
\263\ See Laura Lindsey & Luke C.D. Stein, Angels,
Entrepreneurship, and Employment Dynamics: Evidence from Investor
Accreditation Rules (Working Paper, 2019) (``Lindsey & Stein
(2019)''). This study examines the effects on angel finance stemming
from the Dodd-Frank Act's elimination of the value of the primary
residence in the determination of net worth for purposes of
accredited investor status.
---------------------------------------------------------------------------
Lastly, we expect that the proposed amendments could have an impact
on the market for registered offerings. It is possible that newly
accredited investors shift capital away from registered offerings and
towards unregistered offerings. Such a switch of investment focus could
decrease the amount of capital flowing into registered offerings and
hence negatively affect registered issuers. Due to lack of data, we are
unable to quantify the magnitude of such a potential impact. It is also
conceivable that newly accredited investors do not change their
investment allocations to the registered offerings market but instead
increase investments in unregistered offerings by diverting capital
from other investment opportunities (e.g., savings, real estate). In
this case, we would not expect any significant effect on the market for
registered offerings. We cannot determine how likely each of these
scenarios is.
The remainder of this economic analysis presents the baseline;
anticipated benefits and costs from the proposed amendments; potential
effects on efficiency, competition, and capital formation; and
alternatives to the proposed amendments.
C. Baseline and Affected Parties
The main affected parties of the proposed amendments to the
accredited investor definition would be investors and issuers. For
example, certain non-accredited investors, such as entities that are
currently not designated accredited investors, would become accredited
investors under the proposed amendments and be able to participate in
an expanded array of private offerings. Correspondingly, current
accredited investors may have to compete more intensively to
participate in investment opportunities in this market. Similarly, we
anticipate that certain issuers, such as issuers that are smaller or in
early stages of development, would need to compete less intensively to
solicit accredited investors under the proposed amendments.
We are not able to directly estimate the number of current
accredited investors that would be affected by the proposed amendments
as precise data on the number of individuals and entities that
currently qualify as accredited investors are not available to us. As
noted above, Rule 501(a) of Regulation D uses net worth and income as
bright-line standards to identify natural persons as accredited
investors.\264\
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\264\ Under the current definition, individuals may qualify as
accredited investors if (i) their net worth exceeds $1 million
(excluding the value of the investor's primary residence), (ii)
their income exceeds $200,000 in each of the two most recent years,
or (iii) their joint income with a spouse exceeds $300,000 in each
of those years and the individual has a reasonable expectation of
reaching the same income level in the current year.
---------------------------------------------------------------------------
Using data on household wealth from the SCF database, we estimate
that under the current income and wealth thresholds noted above,
approximately 16.0 million U.S. households, representing 13% of the
total population of U.S. households, qualify as accredited investors.
The data provides
[[Page 2602]]
an estimate of the overall pool of households that qualify as
accredited investors in the United States. This estimate does not,
however, identify the precise number of accredited investors that do or
would invest in the Regulation D market or in other exempt
offerings.\265\
---------------------------------------------------------------------------
\265\ Form D data and other data available to us on private
placements do not allow us to estimate the number of unique
accredited investors that participate in exempt offerings.
---------------------------------------------------------------------------
Based on Form D filings during the period 2009-2018, we estimate
that there were on average approximately 293,700 accredited investors
participating annually in Regulation D offerings.\266\ However, because
an investor can participate in more than one Regulation D offering,
this aggregation likely overstates the actual number of unique
investors, and we lack data to estimate the extent of overlap.
Additionally, from the information reported on Form D, we do not have
the ability to distinguish accredited investors that are natural
persons from accredited investors that are institutions.\267\ The
average number of accredited investors per offering during the period
2009-2018 was 14, and the median number was four.
---------------------------------------------------------------------------
\266\ We estimate the number of accredited investors as the
number of total investors minus the number of non-accredited
investors reported on Form D.
\267\ Other limitations of the data gathered from Form D may
reduce the accuracy of the estimated number of accredited investors.
For example, an issuer is required to file a Form D generally no
later than 15 calendar days after the first sale of securities in a
Regulation D offering, regardless of whether the offering will be
ongoing after the filing of the Form D. Further, issuers are
required to file amendments to Form D only in limited circumstances:
(i) To correct a material mistake of fact or error in a previously
filed Form D, (ii) to reflect a change in certain information
provided in a previously filed Form D, and (iii) on an annual basis
if the offering is continuing at that time. Also, because the Form D
filing requirement is not a condition to claiming an exemption under
Rule 506(b) or 506(c) but rather is a requirement of Regulation D,
it is possible that some issuers do not file Form D when conducting
Regulation D offerings.
---------------------------------------------------------------------------
Table 6 presents evidence on investor participation in Regulation D
offerings by industry type during the period 2009-2018. The
participation of accredited investors in Regulation D offerings during
that period varied by type of issuer as well, with offerings by real
estate investment trusts (REITs) having the largest average number of
accredited investors per offering, and those by operating companies
having the smallest average number.
Table 6--Investors Participating in Regulation D Offerings: 2009-2018
----------------------------------------------------------------------------------------------------------------
Fraction of
Median offerings with
Total number Mean investors investors per one or more
of investors * per offering offering non-accredited
investor (%)
----------------------------------------------------------------------------------------------------------------
Hedge Fund...................................... 30,264 16 2 7
Private Equity Fund............................. 26,518 18 3 3
Venture Capital Fund............................ 8,806 14 3 1
Other Investment Fund........................... 36,651 22 6 4
Financial Services.............................. 12,097 15 4 12
Real Estate..................................... 67,532 26 8 13
Non-financial Issuers........................... 165,606 10 4 9
All offerings................................... 301,286 14 4 9
----------------------------------------------------------------------------------------------------------------
* 2009-2017 data is annualized.
We are not able to directly estimate the number of individuals who
may newly qualify as accredited investors as a result of the proposed
professional certifications or designations as precise data on the
number of current holders of each professional certification or
designation are not available to us. According to data on state-
registered investment advisers compiled by NASAA, there were 17,543
registered investment advisers as of December 2018.\268\ Based on data
from FINRA, we estimate that there were 691,041 FINRA-registered
individuals as of December 2018.\269\ We estimate that 334,860
individuals were registered as only broker-dealers; 294,684 were dually
registered as broker-dealers and investment advisers; and 61,497 were
registered as only investment advisers. However, because FINRA-
registered representatives can hold multiple professional
certifications, this aggregation likely overstates the actual number of
individuals that hold a Series 7 or Series 82, and we have no method of
estimating the extent of overlap.
---------------------------------------------------------------------------
\268\ See 2019 NASAA Investment Adviser Section Annual Report,
available at https://www.nasaa.org/wp-content/uploads/2019/06/2019-IA-Section-Report.pdf.
\269\ See 2019 FINRA Industry Snapshot, available at https://www.finra.org/sites/default/files/2019%20Industry%20Snapshot.pdf.
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We are not able to directly estimate the number of knowledgeable
employees at private funds that would be immediately affected by the
proposed amendments as precise data on the number of knowledgeable
employees of private funds are not available to us. Using data on
private fund statistics compiled by the Commission's Division of
Investment Management, we estimate that there were 32,202 private funds
as of fourth quarter 2018.\270\
---------------------------------------------------------------------------
\270\ See U.S. Securities and Exchange Commission, Division of
Investment Management Fourth Quarter 2018 Private Fund Statistics,
available at https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2018-q4.pdf.
---------------------------------------------------------------------------
Industry observers have estimated that there are 2,500 to 3,000
single family offices managing more than $1.2 trillion in assets.\271\
We lack data to determine the number of family clients of family
offices.
---------------------------------------------------------------------------
\271\ See Pamela J. Black, The Rise of the Multi-Family Office,
Financial Planning (Apr. 27, 2010), https://www.financial-planning.com/news/the-rise-of-the-multi-family-office. A single
family office generally provides services only to members of a
single family.
---------------------------------------------------------------------------
When identifying entities as accredited investors, the current
definition enumerates specific types of entities that would qualify.
Certain enumerated entities are subject to a $5 million asset threshold
to qualify as accredited investors (e.g., tax-exempt charitable
organizations, trusts, and employee benefit plans), while others are
not (e.g., banks, insurance companies, registered broker-dealers,
entities in which all equity owners are accredited investors, private
business development companies, and SBICs). Many of the entities that
are not subject to asset tests are regulated entities. An entity that
is not covered specifically by
[[Page 2603]]
one of the enumerated categories, such as an Indian tribe or sovereign
wealth fund, is generally not an accredited investor under the current
rule.
Publicly reported information provides an indication of the number
of entities, by type, that may currently qualify as accredited
investors. There were 3,764 broker-dealers that filed FOCUS reports
with the Commission for 2018. As of 2018, there were 4,715 FDIC-insured
banks, 691 savings and loan institutions,\272\ and 305 SBICs.\273\
There were 104 business development companies (BDCs) as of December 31,
2018.\274\ There were 5,954 insurance companies as of 2017.\275\ With
respect to the proposed amendments to the accredited investor
definition to add other types of institutional accredited investors,
there were 13,429 registered investment advisers as of 2018 and
approximately 17,500 state-registered investment advisors.\276\
However, we lack data to generate precise estimates of the overall
number of other institutional accredited investors because disclosure
of accredited investor status across all institutional investors is not
required and because, while we have information to estimate the number
of some categories of institutional accredited investors, we lack
comprehensive data that will allow us to estimate the unique number of
investors across all categories of institutional accredited investors
under Rule 501(a).
---------------------------------------------------------------------------
\272\ See FDIC Statistics at a Glance as of June 30, 2019,
available at https://www.fdic.gov/bank/statistical/stats/2019jun/fdic.pdf.
\273\ See Small Business Administration (SBA) SBIC Program
Overview as of March 31, 2019, available at https://www.sba.gov/sites/default/files/2019-05/SBIC%20Quarterly%20Report%20as%20of%20March%2031%202019_0.pdf.
\274\ See Securities Offering Reform for Closed-End Investment
Companies, Release No. 33-10619 (Mar. 10, 2019) [84 FR 14448 (Apr.
10, 2019)].
\275\ See Insurance Information Institute Industry Overview,
available at https://www.iii.org/fact-statistic/facts-statistics-industry-overview#Insurance.
\276\ Identified from Form ADV and FINRA data.
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We also lack data to directly estimate the number of small private
firms that would be potential issuers under the proposed amendments.
Based on analysis of Form D filings, we have identified
approximately 134,345 unique issuers (of which the majority were non-
fund issuers) that have raised capital through Regulation D offerings
from 2009 until 2017. These issuers would benefit from the expansion of
the accredited investor pool under the proposed amendments.
Additionally, newer issuers could be drawn to the Regulation D market
by the expanded pool of accredited investors as a result of the
proposed amendments.
Table 7--Frequency of Regulation D Offerings by Unique Issuers: 2009-2018
----------------------------------------------------------------------------------------------------------------
Non-fund issuers Fund issuers
------------------------------------------------------ All Regulation
Number of offerings Number of Proportion Number of Proportion D issuers
issuers (%) issuers (%)
----------------------------------------------------------------------------------------------------------------
1......................................... 71,452 75.7 49,822 95.5 121,274
2......................................... 11,418 12.1 1,733 3.3 13,151
3......................................... 4,868 5.2 299 0.6 5,167
4......................................... 2,620 2.8 116 0.2 2,736
5......................................... 1,528 1.6 46 0.1 1,574
6 or more Offerings....................... 2,511 2.6 124 0.3 2,635
---------------------------------------------------------------------
Total: Unique Issuers................. 94,397 ........... 52,140 ........... 146,537
----------------------------------------------------------------------------------------------------------------
Lastly, the proposed amendments to the accredited investor
definition likely would impact the market for private offerings in
terms of increased capital raising. As noted above, accredited
investors play a prominent role in Regulation D offerings. As Table 8
shows, in 2018, issuers in the Regulation D market raised approximately
$1.7 trillion. The vast majority of capital raised in this market was
raised under Rule 506(b), which has no limit on the number of
purchasers who are accredited investors and limits the number of non-
accredited investors to 35 per offering. Offerings under Rule 506(c),
under which purchasers are exclusively accredited investors, raised
approximately $211 billion. The largest amount of capital raised in
other exempt offerings, approximately $1.2 trillion, came from Rule
144A offerings.\277\ The total amount of capital raised in the
Regulation A market was approximately $736 million in 2018.
---------------------------------------------------------------------------
\277\ The term ``Rule 144A offering'' refers to a primary
offering of securities by an issuer to one or more financial
intermediaries (commonly known as the ``initial purchasers'') in a
transaction exempt from registration under the Securities Act,
followed by the immediate resale of the securities by the initial
purchasers to qualified institutional buyers in reliance on Rule
144A.
\278\ Data on Regulation D capital raising is taken from Form D
and Form D/A filings. Information on Regulation A capital raising is
taken from Form 1-A and Form 1-A/A filings.
\279\ ``Other exempt offerings'' are identified from Regulation
Crowdfunding, Regulation S, and Rule 144A offerings. The data used
to estimate the amounts raised in 2018 for other exempt offerings
includes data on:
Offerings under Section 4(a)(2) of the Securities Act
that were collected from Thomson Financial's SDC Platinum, which
uses information from underwriters, issuer websites, and issuer SEC
filings to compile its Private Issues database;
offerings under Regulation Crowdfunding that were
collected from Form C filings on EDGAR. For offerings that have been
amended, the data reflects information reported in the latest
amendment as of the end of the considered period. Regulation
Crowdfunding requires an issuers to file a progress update on Form
C-U within 5 business days after reaching 100% of its target
offering amount. The data on Regulation Crowdfunding excludes
withdrawn offerings. Some withdrawn offerings may be failed
offerings. Amounts raised may be lower than the target or maximum
amounts sought.
offerings under Regulation S that were collected from
Thomson Financial's SDC Platinum service; and
resale offerings under Rule 144A that were collected
from Thomson Financial SDC New Issues database, Dealogic, the
Mergent database, and the Asset[hyphen]Backed Alert and Commercial
Mortgage Alert publications to further estimate the number of exempt
offerings under Section 4(a)(2) and Regulation S. We included
amounts sold in Rule 144A resale offerings because those securities
are typically issued initially in a transaction under Section
4(a)(2) or Regulation S but generally are not included in the
Section 4(a)(2) or Regulation S data identified above.
These amounts are accurate only to the extent that these
databases are able to collect such information and may understate
the actual amount of capital raised under these offerings if issuers
and underwriters do not make this data available.
Table 8--Overview of Amounts Raised in the Exempt Market in 2018 \278\
------------------------------------------------------------------------
Amounts reported or estimated
Exemption as raised in 2018
------------------------------------------------------------------------
Rule 506(b) of Regulation D.............. $1.5 trillion.
[[Page 2604]]
Rule 506(c) of Regulation D.............. $211 billion.
Regulation A: Tier 1..................... $60.5 million.
Regulation A: Tier 2..................... $675.3 million.
Rule 504 of Regulation D................. $2 billion.
Other exempt offerings \279\............. $1.2 trillion.
------------------------------------------------------------------------
D. Anticipated Economic Effects
In this section, we discuss the anticipated economic benefits and
costs of the proposed amendments to the accredited investor definition.
Issuers and investors in unregistered offerings are the parties
expected to be most affected by the proposed amendments. We first
analyze the potential costs and benefits of the proposed amendments for
each of these affected parties and then discuss how those effects may
vary based on the characteristics of issuers and investors.
1. Potential Benefits to Issuers
We believe that issuers interested in raising capital through
unregistered offerings could benefit from the proposed amendments.
First, the proposed amendments would likely expand the pool of
accredited investors compared to the current baseline. Expanding the
availability of accredited investors could improve the likelihood of
successfully raising capital in a Regulation D offering and enable a
more efficient and potentially larger capital raising process.
Accredited investors supply the vast majority of capital raised under
Regulation D and are vital to the capital raising needs of issuers
conducting unregistered offerings. By increasing the pool of accredited
investors, issuers may be better able to fulfill their financing needs
with possibly lower costs compared to preparing a registration
statement and at a lower risk of disclosing proprietary information.
Similarly, the proposed amendments could enhance capital formation
in the Regulation A market. As accredited investors are not subject to
investment limits under Tier 2 of Regulation A, expanding the pool of
accredited investors could enable issuers that are conducting offerings
under Tier 2 of Regulation A to raise capital faster and at a
relatively lower cost. In addition, the amendments to the accredited
investor definition could increase capital raising under Rule 504 of
Regulation D. Under Rule 504 of Regulation D, issuers are permitted to
use general solicitation or general advertising to offer and sell
securities when (i) offers and sales are made pursuant to state law
exemptions from registration that permit general solicitation and
general advertising and (ii) sales are made only to accredited
investors as defined in Rule 501(a). An increase in the number of
accredited investors as a result of the rule could increase reliance on
Rule 504.
Expanding the definition of qualified institutional buyer under
Rule 144A would increase the number of potential buyers of Rule 144A
securities, thus facilitating capital formation in this market by
issuers conducting Rule 144A offerings.
In addition to the effects on the ability to raise capital, we
expect the proposed rule to have an effect on the liquidity of
securities issued in unregistered offerings. The proposed amendments to
the qualified institutional buyer definition could also facilitate
resales of Rule 144A securities by holders of these securities by
expanding the pool of potential purchasers in resale transactions. This
could increase demand for Rule 144A securities and have an impact on
the price and liquidity of these securities when offered and sold by
the issuer in Rule 144A offerings and in subsequent resale
transactions. We are unable to quantify, however, the impact of any
such potential changes resulting from the proposed amendments to the
qualified institutional buyer definition.
Additionally, an expanded accredited investor definition could
impact resales under Rule 501 of Regulation Crowdfunding during the
one-year resale restriction period, thus potentially affecting the
liquidity discount for such securities. Securities purchased in a
crowdfunding transaction generally cannot be resold for a period of one
year, unless they are transferred to, among other things, an accredited
investor.\280\ An expanded pool of accredited investors as a result of
the proposed amendments could make it easier for holders of such
securities to find a potential buyer, thus potentially leading to a
lower liquidity discount. Moreover, investors that are seeking to
resell restricted securities and that rely on the Rule 144 safe harbor
for purposes of determining whether the sale is eligible for the
Section 4(a)(1) exemption are required to meet certain conditions under
Rule 144, that can include holding the restricted securities for six
months or one year, depending on the circumstances. An expanded
accredited investor pool could make it easier to conduct a private
resale of restricted securities in a time period shorter than six
months or one year. For example, an investor may seek to rely on the
Section 4(a)(7) exemption for the resale, which requires a number of
conditions to be met, including that the purchaser is an accredited
investor. If the proposed rule changes make it easier to conduct
private resales of restricted securities, this could possibly reduce
the liquidity discount for restricted securities when sold under Rule
506 (or another exemption), making Rule 506 more attractive to issuers
as well as investors. We are unable to quantify, however, any such
potential change in the liquidity for unregistered securities as a
result of the proposed amendments.
---------------------------------------------------------------------------
\280\ See Rule 501 under Regulation Crowdfunding [17 CFR
227.501]. Such securities could also be transferred (i) to the
issuer of the securities; (ii) as part of an offering registered
with the Commission; (iii) to a member of the family of the
purchaser or the equivalent, to a trust controlled by the purchaser,
to a trust created for the benefit of a member of the family of the
purchaser or the equivalent, or in connection with the death or
divorce of the purchaser or other similar circumstance.
---------------------------------------------------------------------------
Another potential benefit to issuers interested in raising capital
through Rule 506(c) offerings is that the proposed amendments would
provide issuers with additional ways to verify an investor's status as
an accredited investor. As discussed in Section II.A above, issuers
conducting offerings under Rule 506(c) are required to take reasonable
steps to verify the accredited investor status of all purchasers in the
offering. Compliance with this verification requirement has been cited
as a potential impediment to the use of Rule 506(c) to raise capital
despite the ability to use general solicitation when conducting these
types of offerings.\281\
[[Page 2605]]
To the extent that issuers may face challenges complying with this
requirement, the proposed amendments would provide issuers with
additional avenues (e.g., professional certifications and investment
tests) to meet this requirement under certain circumstances, which
could facilitate the use of Rule 506(c) as a capital raising option.
---------------------------------------------------------------------------
\281\ See, e.g., Peter Rasmussen, Rule 506(c)'s General
Solicitation Remains Generally Disappointing, Bloomberg (May 26,
2017), https://www.bna.com/rule-506cs-general-b73014451604/. See
also, comments of Jean Peters, Board Member, Angel Capital
Association, at the 33rd Annual SEC Government-Business Forum on
Small Business Capital Formation, Nov. 20, 2014, available at
https://www.sec.gov/info/smallbus/sbforum112014-final-transcript.pdf; Manning G. Warren, The Regulatory Vortex for Private
Placements (Univ. of Louisville Sch. of Law, Legal Studies Research
Paper Series No. 2017-9, 2017) (summarizing discussions with
securities counsel and the results of a survey of counsel
specializing in private placements of securities regarding the
reasons for reluctance to rely on Rule 506(c), including, among
other factors, a reluctance to ``engage in an independent
verification process in order to objectively determine the
accredited investor status of each accredited investor in Rule
506(c) offerings.'' With respect to the last concern, this study
states that ``[m]ost securities lawyers have not yet developed a
comfort level with the necessary `reasonable steps to verify.' . . .
Moreover, this compliance requirement could chill the interests of
many significant investors who have understandable reluctance to
share their tax returns, brokerage statements and other confidential
financial information with issuers' management and attorneys . . .
[S]ome two-thirds of the respondents expressed concerns over
compliance with the verification requirement . . . The possibilities
that accredited investors will walk away from Rule 506(c) offerings
based on privacy concerns clearly contributes to issuer reluctance
to use Rule 506(c) and to a corollary preference to use Rule 506(b)
as the exemption from registration.''). See also Larissa Lee, The
Ban Has Lifted: Now Is the Time to Change the Accredited-Investor
Standard, 2014 Utah L. Rev. 369 (2014); Elan W. Silver, Reaching the
Right Investors: Comparing Investor Solicitation in the Private-
Placement Regimes of the United States and the European Union, 89
Tul. L. Rev. 719 (2015); Dale A. Oesterle, Intermediaries in
Internet Offerings: The Future is Here, 50 Wake Forest L. Rev. 533
(2015).
---------------------------------------------------------------------------
The proposed amendments also would increase the number of potential
investors with whom issuers undertaking a registered offering may be
able to communicate under Section 5(d) of the Securities Act and
Securities Act Rule 163B (the test-the-waters provisions). By
increasing the pool of potential institutional accredited investors and
qualified institutional buyers, the proposed amendments would allow
certain issuers to gather valuable information about investor interest
before a potential registered offering. This could result in a more
efficient and potentially lower-cost and lower-risk capital raising
process for such issuers.
Under Section 12(g) of the Exchange Act,\282\ an issuer that is not
a bank, bank holding company, or savings and loan holding company is
required to register a class of equity securities under the Exchange
Act if, on the last day of its fiscal year, it has more than $10
million in total assets and the securities are ``held of record'' by
either 2,000 or more persons, or 500 or more persons who are not
accredited investors.\283\ To the extent that the proposed amendments
increase the pool of accredited investors, issuers may be able to raise
the capital that they need by selling securities to fewer non-
accredited investors, which could enable these issuers to avoid
becoming an Exchange Act reporting company for a longer period. To the
extent that certain issuers remain non-reporting companies to limit
compliance costs and the risk of disclosure of sensitive information to
potential competitors, the proposed amendments may benefit such issuers
by enabling them to stay non-reporting for a longer period.
---------------------------------------------------------------------------
\282\ 15 U.S.C. 78l(g).
\283\ Id. See also 17 CFR 240.12g-1 (clarifying that accredited
investor status for this purpose is determined as of the last day of
its most recent fiscal year rather than at the time of the sale of
the securities); and Changes to Exchange Act Registration
Requirements Release at Section II.B. (``Under amended Rule 12g-1,
an issuer will need to determine, based on facts and circumstances,
whether prior information provides a basis for a reasonable belief
that the security holder continues to be an accredited investor as
of the last day of the fiscal year.'').
---------------------------------------------------------------------------
A proposed amendment to the accredited investor definition would
allow knowledgeable employees of private funds to qualify as accredited
investors for purposes of investing in offerings by these funds without
the funds themselves losing accredited investor status when the funds
have assets of $5 million or less.\284\ This proposed amendment would
potentially allow these private funds the ability to offer
knowledgeable employees performance incentives, such as investing in
the fund. Permitting employees who participate in the investment
activities of a private fund to hold equity in such private funds may
align incentives between such employees and investors. Although we
expect that the increase in the capital that is supplied to private
funds by knowledgeable employees of these private funds would likely be
relatively small, the potential gains to the funds in incentive
alignment and employee retention could affect fund performance
positively.
---------------------------------------------------------------------------
\284\ Under Rule 501(a)(8), a private fund with assets of $5
million or less may qualify as an accredited investor if all of the
fund's equity owners are accredited investors.
---------------------------------------------------------------------------
2. Potential Benefits to Investors
There is recent empirical evidence that, for a number of reasons,
issuers tend to stay private for longer and have been able to grow to a
size historically available only to their public peers.\285\ This
suggests that the high-growth stage of the lifecycle of many issuers
occurs while they remain private. Thus, investors that do not qualify
for accredited investor status may not be able to participate in the
high-growth stage of these issuers because it often occurs before they
engage in registered offerings.\286\ Allowing more investors to invest
in unregistered offerings of private firms thus may allow them to
participate in the high-growth stages of these firms.
---------------------------------------------------------------------------
\285\ See Michael Ewens & Joan Farre-Mensa, The Deregulation of
the Private Equity Markets and the Decline in IPOs (Nat'l Bureau of
Econ. Research, Working Paper No. 26317, Sept. 2019) (``Ewens &
Farre-Mensa (2019)'').
\286\ For example, according to Ritter (2019), the median age of
a firm that went public in 1999 was 5, and in 2018 the median age
was 10, https://site.warrington.ufl.edu/ritter/files/2019/03/IPOs2018Age.pdf. See Chairman Clayton, Remarks to the New York
Economic Club (Sept. 9, 2019), available at https://www.sec.gov/news/speech/speech-clayton-2019-09-09.
---------------------------------------------------------------------------
We believe that newly eligible accredited investors could benefit
from the proposed amendments as they would gain broader access to
investment opportunities in private capital markets and greater freedom
to make investment decisions based on their own analysis. Generally,
expanding the set of investment opportunities can improve the risk-
return tradeoff of an investor's portfolio.\287\ While private
investments may also offer the opportunity to invest in certain early-
stage or high-growth firms that are not as readily available in the
registered market, private investments, particularly in small and
startup companies, generally pose a high level of risk. For example,
based on Bureau of Labor Statistics (BLS) data on establishment
survival rates, the five-year survival rates for private sector
establishments formed in March 2013 was approximately 51%.\288\ The
higher risks of private investments may be mitigated by investing in
professionally managed private funds rather than selecting private
company investments directly.\289\ Moreover, adding private investments
to the set of investable assets could allow an investor to expand the
efficient risk-return frontier and construct an optimal portfolio with
risk-return properties that are better than, or similar to, the risk-
return properties of a portfolio that is constrained from investing in
certain asset classes. For example, recent research has shown that
investments in funds of private equity funds can outperform public
markets.\290\
---------------------------------------------------------------------------
\287\ See, e.g., John L. Maginn et al., Managing Investment
Portfolios: A Dynamic Process (3rd ed. 2007) (``Maginn et al.
(2007)''); Zvi Bodie, Alex Kane, & Alan J. Marcus, Investments (10th
ed. 2013).
\288\ See BLS business employment dynamics establishment age and
survival data, available at https://www.bls.gov/bdm/bdmage.htm and
https://www.bls.gov/bdm/us_age_naics_00_table7.txt.
\289\ See, e.g., the recommendation to expand retail investor
access to closed-end registered investment funds with significant
exposures to alternatives (https://www.capmktsreg.org/wp-content/uploads/2018/10/Private-Equity-Report-FINAL-1.pdf).
\290\ See, e.g., Robert S. Harris et al., Financial
Intermediation in Private Equity: How Well Do Funds of Funds
Perform?, 129 J. Fin. Econ. 287 (2018).
---------------------------------------------------------------------------
However, comprehensive, market-wide data on the returns of private
investments is not available due to a lack of required disclosure on
these investment returns, the voluntary nature of disclosure of
performance information by private funds, and the
[[Page 2606]]
very limited nature of secondary market trading in these securities.
Academic studies of the returns to private investments acknowledge
limitations and biases in the available data.\291\ For instance, it has
been shown that the data on returns of private investments typically
exhibits a survival bias due to the lack of reporting of
underperforming investments and that the use of appraised valuations to
construct returns on assets that are nontraded can make private
investments seem less risky. There is also a lack of comprehensive data
on angel investment returns \292\ and entrepreneur returns on
investment of their own funds and savings in starting a private
business.\293\
---------------------------------------------------------------------------
\291\ Research has examined (i) private equity returns (see,
e.g., Steven N. Kaplan & Antoinette Schoar, Private Equity
Performance: Returns, Persistence, and Capital Flows, 60 J. Fin.
1791 (2005); Andrew Metrick & Ayako Yasuda, Venture Capital and
Other Private Equity: A Survey, 17 Eur. Fin. Mgmt. 619 (2011);
Christian Diller & Christoph Kaserer, What Drives Private Equity
Returns? Fund Inflows, Skilled GPs, and/or Risk?, 15 Eur. Fin. Mgmt.
643 (2009); Robert S. Harris et al., Financial Intermediation in
Private Equity: How Well Do Funds of Funds Perform?, 129 J. Fin.
Econ. 287 (2018); Robert S. Harris, Tim Jenkinson, & Steven N.
Kaplan, Private Equity Performance: What Do We Know?, 69 J. Fin.
1851 (2014); Kasper Nielsen, The Return to Direct Investment in
Private Firms: New Evidence on the Private Equity Premium Puzzle, 17
Eur. Fin. Mgmt. 436 (2011)); (ii) VC performance (see, e.g., John H.
Cochrane, The Risk and Return of Venture Capital, 75 J. Fin. Econ. 3
(2005); Arthur Korteweg & Stefan Nagel, Risk-Adjusting the Returns
to Venture Capital, 71 J. Fin. 1437 (2016); Axel Buchner, Abdulkadir
Mohamed, & Armin Schwienbacher, Does Risk Explain Persistence in
Private Equity Performance?, 39 J. Corp. Fin. 18 (2016)); and (iii)
hedge fund returns (see, e.g., William Fung & David A. Hsieh, Hedge
Fund Benchmarks: A Risk-Based Approach, Fin. Analysts J., Sept./Oct.
2004, at 65; William Fung & David A. Hsieh, Measurement Biases in
Hedge Fund Performance Data: An Update, Fin. Analysts J., May/June
2009, at 36; Manuel Ammann, Otto R. Huber, & Markus Schmid,
Benchmarking Hedge Funds: The Choice of the Factor Model (Working
Paper, 2011); Zheng Sun, Ashley W. Wang, & Lu Zheng, Only Winners in
Tough Times Repeat: Hedge Fund Performance Persistence over
Different Market Conditions, 53 J. Fin. & Quantitative Analysis 2199
(2018); Charles Cao et al., What Is the Nature of Hedge Fund Manager
Skills? Evidence from the Risk-Arbitrage Strategy, 51 J. Fin. &
Quantitative Analysis 929 (2016); Vikas Agarwal, T. Clifton Green, &
Honglin Ren, Alpha or Beta in the Eye of the Beholder: What Drives
Hedge Fund Flows?, 127 J. Fin. Econ. 417 (2018); Turan G. Bali,
Stephen J. Brown, & Mustafa O. Caglayan, Systematic Risk and the
Cross Section of Hedge Fund Returns, 106 J. Fin. Econ. 114 (2012);
Turan G. Bali, Stephen J. Brown, & Mustafa O. Caglayan,
Macroeconomic Risk and Hedge Fund Returns, 114 J. Fin. Econ. 1
(2014); Andrea Buraschi, Robert Kosowski, & Fabio Trojani, When
There Is No Place to Hide: Correlation Risk and the Cross-Section of
Hedge Fund Returns, 27 Rev. Fin. Stud. 581 (2014); Ravi Jagannathan,
Alexey Malakhov, & Dmitry Novikov, Do Hot Hands Exist Among Hedge
Fund Managers? An Empirical Evaluation, 65 J. Fin. 217 (2010);
Andrea Buraschi, Robert Kosowski, & Worrawat Sritrakul, Incentives
and Endogenous Risk Taking: A Structural View on Hedge Fund Alphas,
69 J. Fin. 2819 (2014); Ronnie Sadka, Liquidity Risk and the Cross-
Section of Hedge-Fund Returns, 98 J. Fin. Econ. 54 (2010); Ilia D.
Dichev & Gwen Yu, Higher Risk, Lower Returns: What Hedge Fund
Investors Really Earn, 100 J. Fin. Econ. 248 (2011)).
\292\ Studies we have identified have used small, selected
samples--sometimes from foreign markets--that do not generalize to
the entire U.S. market. See, e.g., Vincenzo Capizzi, The Returns of
Business Angel Investments and Their Major Determinants, 17 Venture
Cap. 271 (2015) (using a small sample of Italian data); Colin M.
Mason & Richard T. Harrison, Is It Worth It? The Rates of Return
from Informal Venture Capital Investments, 17 J. Bus. Venturing 211
(2002) (using a small UK sample). Investments through AngelList and
similar platforms allow accredited investors to make VC-like
investments in startups. The returns generated by such investments
have been a topic of debate in the literature (see, e.g., Olga
Itenberg & Erin E. Smith, Syndicated Equity Crowdfunding: The Trade-
Off Between Deal Access and Conflicts of Interest (Simon Bus. Sch.,
Working Paper No. FR 17-06, Mar. 2017)).
\293\ See, e.g., Elisabeth Mueller, Returns to Private Equity--
Idiosyncratic Risk Does Matter!, 15 Rev. Fin. 545 (2011) (``Mueller
(2011)''); Thomas Astebro, The Returns to Entrepreneurship, in
Oxford Handbook of Entrepreneurial Finance (Douglas Cumming ed.
2012) (``Astebro (2012)''); Thomas J. Moskowitz & Annette Vissing-
J[oslash]rgensen, The Returns to Entrepreneurial Investment: A
Private Equity Premium Puzzle?, 92 Am. Econ. Rev. 745 (2002)
(``Moskowitz & Vissing-J[oslash]rgensen (2002)''). For instance,
Moskowitz and Vissing-J[oslash]rgensen (2002) examine the returns to
investing in U.S. non-publicly traded equity and find that, although
entrepreneurial investment is extremely concentrated, the returns to
private equity are no higher than the returns to public equity. They
attribute the willingness of households to invest substantial
amounts in a single privately held firm with a seemingly far worse
risk-return trade-off to large nonpecuniary benefits, a preference
for skewness, or overestimated probability of survival.
---------------------------------------------------------------------------
Other aspects of the proposed amendments could provide additional
benefits for investors. For example, persons that are ``knowledgeable
employees'' of a private fund may benefit from increased access to
investment opportunities with the fund as well as the availability of
additional performance incentives. If investments by knowledgeable
employees leads to better incentive alignment between the fund and
investment personnel, other investors in the private fund could
potentially benefit from enhanced fund performance. Additionally,
family clients that are part of a family office would be able to invest
in unregistered offerings as a result of the proposed amendments
without the loss of investor protection benefits. Similarly, the
proposed amendments to allow natural persons to include spousal
equivalents when determining joint income or net worth under Rule 501
of Regulation D would remove unnecessary barriers to investment
opportunities for such investors.
With respect to entities, including additional entity types within
the definition of accredited investor would provide equal access to
investment opportunities for entities with similar attributes of
financial sophistication or the ability to fend for themselves,
regardless of their organizational form. The proposed amendments thus
could help level the playing field among institutional investors and
avoid certain inefficiencies associated with specific corporate forms.
Likewise, the proposed amendment to include a catch-all category of
accredited investor for entities with investments in excess of $5
million would remove impediments to utilizing alternative legal forms
and permit sophisticated investors to take advantage of novel forms of
business organization that may develop in the future, without having to
worry about losing their accredited investor status. Since most family
offices are likely already considered accredited investors, we do not
expect them to receive significant benefits as a result of the proposed
amendments.
3. Potential Costs to Issuers
We also recognize that expanding the pool of accredited investors
could increase the availability of capital to private firms, which
could allow them to stay private longer, thus reducing the number of
companies going public. For example, some academic studies suggest that
the expanding role of private markets has contributed to the decline in
the number of public companies.\294\ Some studies have focused on the
increased flexibility to deregister provided by recent U.S. regulatory
reforms.\295\ Yet other studies generally note the cyclical nature of
offering activity more generally.\296\ How large the impact of the
proposed rule is on the private-public choice is uncertain since there
are a number of factors (e.g., liquidity, cost of capital, ownership
structure, compliance costs, valuations) that an issuer would consider
when determining to go public or stay private.
---------------------------------------------------------------------------
\294\ See Ewens & Farre-Mensa (2019), supra note 284 and Craig
Doidge et al., Eclipse of the Public Corporation or Eclipse of the
Public Markets?, J. Applied Corp. Fin., Winter 2018, at 8.
\295\ See Nuno Fernandes, Ugur Lel, & Darius P. Miller, Escape
from New York: The market impact of loosening disclosure
requirements, 95 J. Fin. Econ. 2 (2010) (focusing on ``Rule 12h-6,
which has made it easier for foreign firms to deregister with the
SEC and thereby terminate their U.S. disclosure obligations'');
Craig Doidge et al., Why Do Foreign Firms Leave U.S. Equity
Markets?, 65 J. Fin. 4, 1507-1553.
\296\ See, e.g., Michelle Lowry, Why does IPO Volume fluctuate
so much?, 67 J. Fin. Econ. 1 (2003), 3-40; Alti (2005); and Chris
Yung et al., Cycles in the IPO Market, 89 J. Fin. Econ. 1 (2008),
192-208.
---------------------------------------------------------------------------
4. Potential Costs to Investors
Newly eligible accredited investors would have access to more
investment
[[Page 2607]]
options under the proposed amendments. Some of these investment options
could entail greater risk of loss. Thus, newly eligible accredited
investors could face greater overall investment risk under the proposed
amendments. The proposal is designed to limit the costs to investors by
ensuring that accredited investor status is only afforded to investors
that are either financially sophisticated and therefore able to fend
for themselves or are able to sustain the risk of loss. To the extent
that the ways we are proposing to expand the pool of potential
accredited investors would include investors that are not financially
sophisticated, such investors in this expanded state would bear the
costs we discuss below.
We anticipate that some natural person investors who do not meet
the income and wealth thresholds under the current definition, but that
would qualify as accredited investors under the proposed amendments,
may not be able to sustain a loss of investment in an unregistered
offering. For example, an individual that has obtained a Series 7
license or is a knowledgeable employee of a private fund may possess
experience in investing but may be less able to withstand investment
losses than an accredited investor qualifying on the basis of personal
wealth. However, we believe this risk would be mitigated by the fact
that the proposed amendments are intended to better identify investors'
financial sophistication, which includes an ability to assess and avoid
a risk of loss that the investor cannot sustain.
Investing in securities that are acquired in exempt offerings could
reduce investors' liquidity while increasing their transaction and
agency costs. Investors may experience reductions in liquidity by
investing in these securities, as secondary market liquidity in these
offerings remains limited. This illiquidity is generally related to
legal restrictions on the transferability of securities issued in many
exempt offerings; a lack--or a very limited nature--of a trading
market; \297\ long-term horizon for exits for private issuers; and, in
cases of private funds investing in private issuers, standard
contractual terms designed to enable a long-term horizon for the
portfolio.\298\ Investing in securities of private companies for which
less information is publicly available, also could increase the agency
costs for accredited investors. Since the vast majority of capital that
is raised in exempt offerings is not accompanied by disclosures that
are comparable to public companies' disclosures, investors would
potentially have less information about these private companies
compared to similar public companies, and they may not be able to
effectively monitor the management of these companies. As a result,
investors in securities of private companies may bear a heightened risk
that management may take actions that reduce the value of their stakes
in such companies without such actions being disclosed. However, we
believe that the risk of accredited investors not being able to manage
their liquidity or agency risk would be mitigated because these
investors are presumed to be financially sophisticated.
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\297\ See, e.g., David F. Larcker, Brian Tayan, & Edward Watts,
Cashing It In: Private-Company Exchanges and Employee Stock Sales
Prior to IPO, Stanford Closer Look Series (Sept. 12, 2018). See also
Concept Release.
\298\ See, e.g., Private Equity: Fund Types, Risks and Returns,
and Regulation (Douglas Cumming ed., 2011).
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While investing in securities acquired in exempt offerings may
increase an investor's diversification (as discussed above), there are
practical frictions that can make it difficult for an investor to
diversify risk using these investments. For example, investment
minimums demanded by certain issuers may decrease or eliminate the
diversification benefits of incorporating private investments in an
individual investor's portfolio. Moreover, the increased competition
amongst investors under an expanded accredited investor definition
could lower investors' expected returns for private assets. That is, as
more capital is available in the non-registered markets, investors
could receive lower returns due to the entry of newly-accredited
investors with a lower required rate of return or reduced search
frictions associated with finding accredited investors. Further, it has
been shown that the data on returns of private investments typically
exhibits smoothing due to the infrequent nature of observation of
returns and/or the use of appraised valuations and other methods to
construct returns on assets that are nontraded.\299\ This can result in
an investor significantly overestimating the diversification benefits
of private investments and underestimating the risk of private
investments.\300\ Additionally, when compared to traded securities of
public companies, private investments may be characterized by
considerable downside and tail risk due to the frequently non-normally
distributed returns.\301\ We think that the likelihood that accredited
investors misunderstand the risk profile and associated portfolio
constraints of securities acquired in exempt offerings is relatively
low, as these investors are presumed to be financially sophisticated.
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\299\ See, generally, Gregory W. Brown, Oleg R. Gredil, & Steven
N. Kaplan, Do Private Equity Funds Manipulate Reported Returns?, 132
J. Fin. Econ. 267 (2019); Arthur Korteweg, Risk Adjustment in
Private Equity Returns (Working Paper, 2018).
\300\ See, generally, Maginn et al. (2007), supra note 286. See
also Kenneth Emery, Private Equity Risk and Reward: Assessing the
Stale Pricing Problem, J. Private Equity, Spring 2003, at 43; Arthur
Korteweg & Morten Sorensen, Risk and Return Characteristics of
Venture Capital-Backed Entrepreneurial Companies, 23 Rev. Fin. Stud.
3738 (2010); Gregory W. Brown, Oleg R. Gredil, & Steven N. Kaplan,
Do Private Equity Funds Manipulate Reported Returns?, 132 J. Fin.
Econ. 267 (2019); Arthur Korteweg, Risk Adjustment in Private Equity
Returns (Working Paper, 2018).
\301\ See, e.g., Mueller (2011), supra note 292; Astebro (2012),
supra note 292; Moskowitz & Vissing-J[oslash]rgensen (2002), supra
note 292. For instance, Moskowitz and Vissing-J[oslash]rgensen
(2002) examine the returns to investing in U.S. non-publicly traded
equity and find that, although entrepreneurial investment is
extremely concentrated, the returns to private equity are no higher
than the returns to public equity. They attribute the willingness of
households to invest substantial amounts in a single privately held
firm with a seemingly far worse risk-return trade-off to large
nonpecuniary benefits, a preference for skewness, or overestimated
probability of survival.
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The proposed amendments could increase agency costs and reduce
efficient capital allocation if investors are solicited with less
information. Further, the combined presence of small individual
investors without control rights and insiders or large private
investors with concentrated control rights is likely to lead to agency
conflicts. Such agency conflicts, as well as potentially an inability
to negotiate preferential terms (such as downside protection options,
liquidation preferences, and rights of first refusal) might place
individual accredited investors, dollar-for-dollar, at a disadvantage
to insiders and large investors. The impact of agency conflicts on
minority investors in private companies might be relatively more
significant than at exchange-listed companies because private companies
generally are not subject to the governance requirements of exchanges
or various proxy statement disclosures. However, as accredited
investors are presumed to be financially sophisticated, we anticipate
that they will have the experience, resources, and incentives to screen
private offerings from both non-reporting and reporting issuers.
5. Variation in Economic Effects
The magnitude of the benefits and costs discussed above are
expected to vary depending on the particular attributes of the affected
issuers and investors.
[[Page 2608]]
With respect to issuers, we expect the proposed changes to be most
valuable for firms that have greater uncertainty about the interest in
their prospective offerings, particularly ones that are small, in
development stages, or in geographic areas that currently have lower
concentrations of accredited investors. Household income and net worth
tend to be higher in the Northeast and West regions. Thus, issuers that
are not in those regions may find it more difficult to solicit
qualified accredited investors. For example, based on DERA staff
analysis of Form 1-A filings from June 2015 to December 2018,
approximately 24% of Regulation A issuers were located in California,
10% in Florida, and 8% in New York. Additionally, small businesses
typically do not have access to registered capital markets and commonly
rely on personal savings, business profits, home equity loans, and
friends and family as initial sources of capital.\302\ Small issuers
that face more challenges in raising external financing may benefit
more from increased access to accredited investors.\303\ In particular,
businesses owned by underrepresented minorities may benefit from
increased access to accredited investors. For example, based on the
2014 Annual Survey of Entrepreneurs, 28.4% of Black entrepreneurs and
17.5% of Hispanic entrepreneurs cited limited access to financial
capital as having a negative impact on their firms' profitability.\304\
Additionally, despite being more likely to seek new sources of funding,
businesses owned by underrepresented minorities were more likely to
demonstrate unmet credit needs relative to other groups,\305\ which
suggests that these businesses may benefit from amendments intended to
facilitate private market capital raising.
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\302\ See 2017 Treasury Report.
\303\ See Lindsey & Stein (2019), supra note 262.
\304\ Alicia Robb, ``Financing Patterns and Credit Market
Experiences: A Comparison by Race and Ethnicity for U.S. Employer
Firms,'' a study for the Office of Advocacy, U.S. Small Bus. Admin.
(Feb. 2018), available at https://www.sba.gov/sites/default/files/Financing_Patterns_and_Credit_Market_Experiences_report.pdf.
\305\ Id.
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We expect that issuers that predominately offer and sell securities
in registered offerings or that market their offerings to non-
accredited investors would be less likely to be affected by the
proposed amendments. We expect the incremental benefits of the proposed
amendments to be smaller for large and well-established issuers with
low information asymmetry and a history of public disclosures, as these
issuers likely have ready access to accredited investors, especially
institutional accredited investors. Similarly, issuers with low costs
of proprietary disclosure (e.g., low research and development intensity
and limited reliance on proprietary technology) may be less likely to
benefit from the proposed amendments as they may be less reliant on
exempt offerings.
With respect to investors, we expect the benefits and costs of the
proposed amendments to be most immediately realized by new entrants to
the pool of accredited investors, particularly entities that are not
included in the current accredited investor definition and individuals
that have professional certifications that do not meet the current
income and net worth thresholds. We also expect that providing
additional measures of financial sophistication, other than personal
wealth, could expand investment opportunities for individual investors
in geographic regions with a lower cost of living.
6. Competition, Efficiency, and Capital Formation
The Commission believes that the proposed amendments are likely to
facilitate capital formation by increasing issuers' access to
accredited investors and increasing investors' access to capital
markets. The impacts of the proposed amendments on competition,
efficiency, and capital formation are discussed throughout this section
and elsewhere in this release. The following discussion highlights
several such impacts.
Most of the proposed amendments would expand the pool of accredited
investors beyond the current baseline.
The increased pool of accredited investors could result in
increased amounts of capital available to private issuers, thus
increasing capital formation. Expanding the pool of accredited
investors could also make the capital raising process more efficient by
allowing potentially newer and informed investors to enter the market
for private offerings. If the newly accredited investors bring new and
uncorrelated information signals to the market (e.g., because of their
specialized knowledge and skills), such an increase in the number of
investors could improve the price discovery process and make the market
for private offerings more efficient. The increased pool of accredited
investors could also enhance competition among investors in the market
for private offerings, thus reducing the cost of capital for potential
issuers and improving allocative efficiency.
The expansion of the accredited investor pool could also reduce the
capital allocated to public markets if public markets attract
relatively fewer offerings. Further, to the extent that an efficient
market incorporates firm-specific information quickly and correctly,
such an expansion could reduce the efficiency of public markets if
there are fewer companies making disclosures into public markets. As
discussed previously, various academic studies have attributed the
expanding role of private markets as a contributing factor to the
decline in the number of public U.S. companies over the past two
decades.\306\ Alternatively, another strand of academic literature
pinpoints changes in the economies of scope and business structure that
have decreased the feasibility and attractiveness of operating as a
standalone small or medium-sized company as driving factors in the
decline in the number of public companies and new listings.\307\ As an
important caveat, while some of the cited evidence allows side-by-side
comparisons of aggregate trends in listings, IPOs, private placements,
and mergers, it does not necessarily establish conclusive causal
relations between the expansion of private markets and the contraction
in the number of public U.S. companies.
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\306\ See, e.g., Ewens & Farre-Mensa (2019), supra note 284;
Craig Doidge et al., Eclipse of the Public Corporation or Eclipse of
the Public Markets?, J. Applied Corp. Fin., Winter 2018, at 8.
\307\ According to this literature, small and medium-sized
companies increasingly follow the path of being acquired by larger
competitors in lieu of going and remaining public, which accounts
for the decline in IPOs and new listings, particularly of small and
medium-sized companies. Being bought by a larger firm offers
potential advantages to a smaller company, including speeding a
product to market and helping smaller businesses realize ``economies
of scope.'' See, e.g., Xiaohui Gao, Jay R. Ritter, & Zhongyan Zhu,
Where Have All the IPOs Gone?, 48 J. Fin. & Quantitative Analysis
1663 (2013); Jay R. Ritter, Equilibrium in the Initial Public
Offerings Market, 3 Ann. Rev. Fin. Econ. 347 (2011) (stating that
although regulatory burdens account for some of the decline, much of
the decline is due to a structural shift that has lessened the
profitability of small independent companies relative to their value
as part of a larger, more established organization that can realize
economies of scope); Jay R. Ritter, Re-Energizing the IPO Market
(Working Paper, 2012) (similarly focused on the economies of scope
hypothesis); Paul Rose & Steven Davidoff Solomon, Where Have All the
IPOs Gone? The Hard Life of the Small IPO, 6 Harv. Bus. L. Rev. 83
(2016) (examining 3,081 IPOs from 1996-2012 and concluding that the
decline in small IPOs appears more attributable to the ``historical
unsuitability of small firms for the public markets''); Andrea
Signori & Silvio Vismara, M&A Synergies and Trends in IPOs (Working
Paper, 2016); Jay R. Ritter, Andrea Signori, & Silvio Vismara,
Economies of Scope and IPO Activity in Europe, in Handbook of
Research on IPOs (Mario Lewis & Silvio Vismara eds., 2013), at 11
(attributing the decline in European IPOs to market conditions and
to economies of scope).
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[[Page 2609]]
To the extent that the proposed amendments better identify an
investor's financial sophistication (e.g., professional certifications
for natural persons and an investments-owned threshold for entities),
the expanded definition may increase market efficiency by allowing more
informed investors into a larger segment of the capital market. The
expanded pool of accredited investors could also increase the capital
that is supplied to private markets, thereby potentially lowering
investors' expected returns from investing in this market.
Additionally, as discussed above, expanding the accredited investor
definition to include knowledgeable employees of a private fund could
lead to better alignment between private funds and investors. The
improved alignment could enable private funds to perform investing
services more efficiently and effectively, thus potentially improving
investor protection and market efficiency over the long term.
7. Alternatives
In this section, we evaluate reasonable alternatives to the
proposed amendments. First, the Commission could leave the current
income and net worth thresholds in place as proposed, but impose
certain investment limitations. Inflation has expanded significantly
the number of individuals who qualify as accredited investors based on
income and net worth. Limiting investment amounts for individuals who
qualify as accredited investors based solely on the current income or
net worth thresholds could provide protections for those individuals
who are less able to bear financial losses. For example, the Commission
could consider limiting investments for individuals who qualify as
accredited investors solely based on the current thresholds to a
percentage of their income or net worth (e.g., 10% of prior year income
or 10% of net worth, as applicable, per issuer, in any 12-month
period). This alternative, however, would result in a smaller pool of
accredited investors, reduce capital formation, and likely increase the
implementation costs associated with verifying an investor's status as
an accredited investor and her eligibility to participate in an
offering.
The Commission also could consider increasing the individual income
thresholds from $200,000 to $538,000 and the net worth threshold from
$1 million to $2.7 million to reflect the impact of inflation since
1982. Such an alternative could provide further assurance that
individuals eligible for accredited investor status are those investors
who do not need protections rendered by registration under the
Securities Act. Using the SCF, we estimate that an immediate catch-up
inflation adjustment would shrink the accredited investor pool to 5.3
million households (representing 4.2% of the population of U.S.
households) from the current pool of approximately 16 million
households (representing 13% of the population of U.S. households).
Thus, increasing the individual income and net worth thresholds would
greatly reduce the number of natural persons who would qualify as
accredited investors. Moreover, an immediate catch-up inflation
adjustment would likely reduce the number of accredited investors in
geographic areas with lower cost of living. As such, the adjusted
income and wealth thresholds also could potentially increase the costs
that issuers face by reducing issuers' access to capital and reducing
investors' access to private investment opportunities. As discussed
above in Section VII.B, accredited investors supplied 94% of the $1.5
trillion raised in Rule 506(b) offerings in 2018. Significantly
reducing the pool of accredited investors through an immediate catch-up
inflation adjustment could thus have disruptive effects on capital
raising activity in the Regulation D market.
The Commission also could consider indexing the financial
thresholds in the definition for inflation on a going-forward basis,
rounded to the nearest $10,000 every four years following the effective
date of the final rule amendment. This alternative likely would reduce
the change in the number of accredited investors relative to the
baseline of leaving the thresholds fixed, holding all else constant.
Using the 2016 SCF, we estimate that in 2019, had the current wealth
and income thresholds been adjusted for inflation since 2015 and 2010,
the proportion of U.S. households that would qualify as accredited
investors would have been 11.4% and 10.4%, respectively, which is
consistent with an inflation adjustment reducing the pool of accredited
investors relative to the baseline.
If the Commission modifies the accredited investor definition as
described above, the Commission also could consider grandfathering
issuers' current investors who meet and continue to meet the current
accredited investor standards with respect to future offerings of the
securities of issuers in which the investors are invested at the time
of the change. Grandfathering would provide protection from investment
dilution for any person who no longer would be an accredited investor
because of any changes to the definition. The grandfathering provision
could apply to future investments in the same issuer only, and not to
future investments in affiliates of the issuer. Grandfathering current
investors would help to mitigate--although it likely would not
completely eliminate--the potential disruptive effect to the Regulation
D market of an immediate catch-up inflation adjustment.
As an alternative to the proposed amendments, the Commission could
permit individuals with a minimum amount of investments to qualify as
accredited investors. Investments may in some cases be a more
meaningful measure of individuals' experience with and exposure to the
financial and investing markets than income or net worth. An
``investments'' definition based on the definition of investments in
Rule 2a51-1(b) would promote consistency across securities laws and
provide a predictable framework. In 2007, the Commission proposed
applying a $750,000 minimum investments-owned threshold.\308\ Using the
SCF to measure households' financial and nonfinancial wealth (excluding
the value of a primary residence), we estimate that an investment-owned
test of $750,000 would increase the number of households that would
currently qualify as accredited investors from approximately 16 million
households (representing 13% of the population of U.S. households) to
18.2 million households (representing 14.5% of the population of U.S.
households). Thus, this alternative likely would increase the pool of
accredited investors relative to the baseline. On the other hand, an
unconditional investments-owned test that does not take into account a
natural person's indebtedness or income could reduce investor
protections relative to the baseline if individuals use leverage to
fund their investments.
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\308\ See 2007 Proposing Release.
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As another alternative to the proposed amendments, the Commission
could permit individuals with experience investing in exempt offerings
to qualify as accredited investors. For example, the Commission could
consider adding a new category to the accredited investor definition
that includes individuals who have invested in at least ten private
securities offerings, each conducted by a different issuer, under
Securities Act Section 4(a)(2), Rule 506(b), or Rule 506(c). Expanding
the accredited investor definition to include individuals with relevant
investment experience would recognize
[[Page 2610]]
an objective indication of financial sophistication. These individuals
presumably have developed knowledge about the private capital markets,
including their inherent risks. This experience may include performing
due diligence, negotiating investment terms, and making valuation
determinations. This alternative would increase the pool of accredited
investors, although by less than the proposed amendments. At the same
time, this alternative could significantly increase the implementation
costs of determining an investor's status as an accredited investor, as
verifying an individual's relevant investment experience likely would
be cumbersome.
The Commission could also permit certain knowledgeable employees of
a non-fund issuer to qualify as accredited investors in securities
offerings of that issuer. For example, an employee that is an officer
at a company should have access to the necessary information about that
company to make an informed investment should the company decide to
issue securities. Expanding the accredited investor definition to
include certain knowledgeable employees of a non-fund issuer would
increase the pool of accredited investors relative to the baseline, and
could allow non-fund issuers to raise additional capital and
potentially increase incentive alignments between employees and
shareholders. On the other hand, this alternative could reduce investor
protections, to the extent that a knowledgeable employee may be
informed about a company's business operations, but not possess the
relevant financial sophistication to assess the company's offerings.
Finally, the Commission could add even more specific entity types
to the enumerated entity types in Rule 501(a), instead of the proposal
to include all entities that meet an investments-owned test. For
example, the Commission could expand the enumerated entity types in
Rule 501(a) to include additional entity types such as Indian tribes
and sovereign wealth funds. As detailed above in Section VII.D, adding
specific entity types to the enumerated entity types in Rule 501(a)
would expand the pool of accredited investors relative to the baseline.
On the other hand, this alternative would result in a smaller number of
new institutional accredited investors compared to the proposed
amendments. Another alternative would be to apply an asset test for the
new entities instead of an investments-owned test. An asset test would
help to level the playing field among institutional investors and would
reduce inefficiencies associated with specific corporate forms that
could develop in the future relative to the current baseline. Moreover,
an asset test would likely increase the number of new institutional
investors that would qualify as accredited investors relative to an
investments-owned test, as, all else equal, we expect more entities to
have $5 million in assets than would have $5 million in investments. At
the same time, to the extent that an investments-owned test is a better
indicator of those investors who do not need the protections rendered
by registration under the Securities Act than an asset test, this
alternative could result in lower levels of market efficiency and
investor protection compared to the proposed amendments.
Request for Comment
We request comment on all aspects of our economic analysis,
including the potential benefits and costs of the proposed amendments
and alternatives to the proposed amendments, and whether the proposed
amendments, if adopted, would promote efficiency, competition, and
capital formation or have an impact on investor protection. Commenters
are requested to provide empirical data, estimation methodologies, and
other factual support for their views, in particular, on the estimates
of costs and benefits for the affected parties.
70. Would expanding the accredited investor definition to encompass
natural persons that are advised by investment professionals impact
market efficiency, competition, capital formation, or investor
protection? If so, what would those impacts be?
71. Does the current exempt offering framework provide certain
issuers with sufficient access to accredited investors? For example,
are there capital-raising needs specific to any of the following that
are currently not being met due to limited access to accredited
investors: Issuers in particular industries, such as technology,
biotechnology, or manufacturing; or issuers led by underrepresented
minorities, women, or veterans? Is there quantitative data available
that shows the extent to which accredited investors fulfill the capital
raising needs of these issuers? Would amending the accredited investor
definition in the manner we propose address any such financing gaps?
72. How should we evaluate whether our current exempt offering
framework provides adequate investor protection for accredited
investors? For example, is there quantitative data available that shows
an increased incidence of fraud in particular types of exempt offerings
or in the market for exempt offerings as a whole? If yes, is there any
reliable way to predict whether the proposed amendments could have any
effect on the incidence of fraud in exempt offerings? What other
factors should we consider in assessing fraud in exempt offerings?
VIII. Paperwork Reduction Act
We do not believe that the proposed amendments would impose any new
``collection of information'' requirement as defined by the Paperwork
Reduction Act of 1995,\309\ nor create any new filing, reporting,
recordkeeping, or disclosure requirements. As discussed in Sections II,
III, V and VII above, by expanding the pool of accredited investors,
the proposed amendments could facilitate exempt offerings conducted
pursuant to Regulation D or Regulation A and/or enable some companies
to defer becoming a public reporting company, which may impact the
number of annual responses under associated collections of
information.\310\ It is difficult to estimate the magnitude of these
effects as they would depend on a number of factors. Overall, however,
we expect any impact on the annual number responses for associated
collections of information to be incremental and relatively small, and
therefore we are not proposing to adjust the burden estimates for these
collections of information at this time. Accordingly, we are not
submitting the proposed amendments to the Office of Management and
Budget for review under the Paperwork Reduction Act.\311\ We request
comment on our assessment that the proposed amendments would not create
any new, or revise any existing, collection of information pursuant to
the Paperwork Reduction Act. We also request comment on whether the
proposed amendments would impact the number of annual responses for any
associated collections of information and, if so, how we should adjust
our PRA burden estimates to reflect this impact.
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\309\ 44 U.S.C. 3501 et seq.
\310\ These collections of information include: Form D (3235-
0076), Form 1-A (3235-0286), Form 1-K (3235-0720), Form 1-SA (3235-
0721), Form 1-U (3235-0722).
\311\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
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IX. Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (SBREFA),\312\ the Commission must advise OMB as to whether
the proposed amendments constitute a ``major'' rule. Under SBREFA, a
rule is
[[Page 2611]]
considered ``major'' where, if adopted, it results or is likely to
result in:
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\312\ 5 U.S.C. 801 et seq.
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An annual effect on the U.S. economy of $100 million or
more (either in the form of an increase or a decrease);
A major increase in costs or prices for consumers or
individual industries; or
Significant adverse effects on competition, investment, or
innovation.
Request for Comment
We request comment on whether the proposed amendments would be a
``major rule'' for purposes of SBREFA. In particular, we request
comment on the potential effect of the proposed amendments on the U.S.
economy on an annual basis; any potential increase in costs or prices
for consumers or individual industries; and any potential effect on
competition, investment or innovation. Commenters are requested to
provide empirical data and other factual support for their views to the
extent possible.
X. Initial Regulatory Flexibility Analysis
When an agency issues a rulemaking proposal, the Regulatory
Flexibility Act (``RFA'') \313\ requires the agency to prepare and make
available for public comment an Initial Regulatory Flexibility Analysis
(``IRFA'') that will describe the impact of the proposed rule on small
entities.\314\ This IRFA relates to proposed amendments to Rules 215
and 501(a) of the Securities Act.\315\
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\313\ 5 U.S.C. 601 et seq.
\314\ 5 U.S.C. 603(a).
\315\ Because the proposed changes to Rule 144A of the
Securities Act relate to entities that in the aggregate own and
invest on a discretionary basis at least $100 million in securities
of issuers that are not affiliated with the entity, we do not
believe the proposed changes to Rule 144A would have an impact on
small entities.
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A. Reasons for, and Objectives of, the Proposed Action
The primary objective of the proposed amendments is to update and
improve the definitions of accredited investor and qualified
institutional buyer. The reasons for, and objectives of, the proposed
amendments are discussed in more detail in Sections II through IV
above.
B. Legal Basis
We are proposing the amendments pursuant to Sections 2(a)(11),
2(a)(15), 4(a)(1), 4(a)(3)(A), 4(a)(3)(C), 19(a), and 28 of the
Securities Act and Sections 3(a)(51)(B), 3(b), 15(c), 15(g), and 23(a)
of the Exchange Act.
C. Small Entities Subject to the Proposed Rule
The proposed amendments would affect issuers that are small
entities. The RFA defines ``small entity'' to mean ``small business,''
``small organization,'' or ``small governmental jurisdiction.'' \316\
For purposes of the RFA, under 17 CFR 230.157, an issuer, other than an
investment company, is a ``small business'' or ``small organization''
if it had total assets of $5 million or less on the last day of its
most recent fiscal year and is engaged or proposing to engage in an
offering of securities not exceeding $5 million. Under 17 CFR 240.0-
10(a), an investment company, including a business development company,
is considered to be a small entity if it, together with other
investment companies in the same group of related investment companies,
has net assets of $50 million or less as of the end of its most recent
fiscal year.
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\316\ [thinsp]5 U.S.C. 601(6).
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The proposed amendments would allow more investors to qualify as
accredited investors, which would permit all issuers, including small
entities, to offer and sell securities in the private markets to more
investors. Because the proposed amendments would affect all issuers,
both reporting and non-reporting, it is difficult to estimate the
number of issuers that qualify as small issuers that would be eligible
to rely on the proposed amendments.
D. Projected Reporting, Recordkeeping and Other Compliance Requirements
The proposed amendments do not impose any new reporting or
recordkeeping requirement, although, as with any Regulation D offering,
the issuer must file a Form D with the Commission when conducing an
offering under the exemptions provided in Regulation D. Further, small
entities are not required to offer and sell securities to accredited
investors who would be newly qualified under the proposed rules. As a
result, we do not expect the proposed amendments to significantly
impact existing reporting, recordkeeping, and other compliance burdens.
Small entities choosing to avail themselves of the proposed amendments
may seek the advice of legal or accounting professionals in connection
with offers and sales to accredited investors. We discuss the economic
impact, including the estimated costs and benefits, of the proposed
amendments to all issuers, including small entities, in Section VII
above.
E. Duplicative, Overlapping, or Conflicting Federal Rules
We do not believe the proposed amendments would duplicate, overlap,
or conflict with other federal rules, although, as discussed in Section
V, the proposed amendments could have implications for a number of
other contexts under the federal securities laws.
F. Significant Alternatives
The RFA directs us to consider alternatives that would accomplish
our stated objectives, while minimizing any significant adverse impact
on small entities. In connection with the proposed amendments, we
considered the following alternatives:
Establishing different compliance or reporting
requirements that take into account the resources available to small
entities;
Clarifying, consolidating, or simplifying compliance and
reporting requirements under the rules for small entities;
Using performance rather than design standards; and
Exempting small entities from all or part of the
requirements.
The proposed amendments would not establish any new reporting,
recordkeeping, or compliance requirements for small entities and, as
noted above, small entities are not required to offer and sell
securities to accredited investors who would be newly qualified under
the proposed rules. Accordingly, we do not believe it is necessary to
exempt small entities from all or part of the proposed amendments or to
consider different or simplified compliance requirements for these
entities. To the extent that issuers may face challenges complying with
the requirement in Rule 506(c) of Regulation D to verify an accredited
investor's status, the proposed amendments would provide issuers,
including small entities, with additional ways to meet this
verification requirement that are objective and readily verifiable.
G. Request for Comment
We encourage the submission of comments with respect to any aspect
of this Initial Regulatory Flexibility Analysis. In particular, we
request comments regarding:
The number of small entities that may be affected by the
proposed amendments;
The existence or nature of the potential impact of the
proposed
[[Page 2612]]
amendments on small entity issuers discussed in the analysis; and
How to quantify the impact of the proposed amendments.
Commenters are asked to describe the nature of any impact and
provide empirical data supporting the extent of the impact. Comments
will be considered in the preparation of the Final Regulatory
Flexibility Analysis, if the proposed amendments are adopted, and will
be placed in the same public file as comments on the proposed
amendments themselves.
XI. Statutory Authority and Text of Proposed Rule Amendments
The amendments contained in this release are being proposed under
the authority set forth in Sections 2(a)(11), 2(a)(15), 4(a)(1),
4(a)(3)(A), 4(a)(3)(C), 19(a), and 28 of the Securities Act and in
Sections 3(a)(51)(B), 3(b), 15(c), 15(g), and 23(a) of the Exchange
Act.
List of Subjects in 17 CFR Parts 230 and 240
Reporting and recordkeeping requirements, Securities.
For the reasons set out above, the Commission proposes to amend
Title 17, chapter II of the Code of Federal Regulations, as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
0
1. The authority citation for part 230 continues to read as follows:
Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h,
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126
Stat. 313 (2012), unless otherwise noted.
* * * * *
0
2. Amend Sec. 230.144A by:
0
a. Revising paragraphs (a)(1)(i)(C) and(H);
0
b. Removing the ``.'' at the end of paragraph (a)(1)(i)(I) and additing
in its place ``and ;''; and
0
c. Adding a new paragraph (a)(1)(i)(J).
The revisions and addition read as follows:
Sec. 230.144A Private resales of securities to institutions.
(a) * * *
(1) * * *
(i) * * *
(C) Any Small Business Investment Company licensed by the U.S.
Small Business Administration under section 301(c) or (d) of the Small
Business Investment Act of 1958 or any Rural Business Investment
Company as defined in section 384A of the Consolidated Farm and Rural
Development Act;
* * * * *
(H) Any organization described in section 501(c)(3) of the Internal
Revenue Code, corporation (other than a bank as defined in section
3(a)(2) of the Act or a savings and loan association or other
institution referenced in section 3(a)(5)(A) of the Act or a foreign
bank or savings and loan association or equivalent institution),
partnership, limited liability company, or Massachusetts or similar
business trust;
* * * * *
(J) Any institutional accredited investor, as defined in rule
501(a) under the Act (17 CFR 230.501(a)), of a type not listed in
paragraphs (a)(1)(i)(A) through (I) or paragraphs (a)(1)(ii) through
(vi).
* * * * *
0
3. Amend Sec. 230.163B by revising paragraph (c)(2) to read as
follows:
Sec. 230.163B Exemption from section 5(b)(1) and section 5(c) of the
Act for certain communications to qualified institutional buyers or
institutional accredited investors.
* * * * *
(c) * * *
(2) Institutions that are accredited investors, as defined in
Sec. Sec. 230.501(a)(1), (a)(2), (a)(3), (a)(7), (a)(8), (a)(9), or
(a)(12).
0
4. Revise Sec. 230.215 to read as follows:
Sec. 230.215 Accredited investor.
The term accredited investor as used in section 2(a)(15)(ii) of the
Securities Act of 1933 (15 U.S.C. 77b(a)(15)(ii)) shall have the same
meaning as the definition of that term in rule 501(a) under the Act (17
CFR 230.501(a)).
0
5. Amend Sec. 230.501 by:
0
a. Revising paragraphs (a)(1) and (a)(3);
0
b. Revising the first sentence of paragraph (a)(5);
0
c. Adding a note to paragraph (a)(5);
0
d. Revising paragraph (a)(6);
0
e. Removing the word ``and'' at the end of paragraph (a)(7);
0
f. Replacing the ``.'' at the end of paragraph (a)(8) with a ``;'';
0
g. Adding a note to praragraph (a)(8);
0
h. Adding paragraphs (a)(9) through (13);
0
i. And adding paragraph (j).
The revisions and additions read as follows:
Sec. 230.501 Definitions and terms used in Regulation D.
(a) * * *
(1) Any bank as defined in section 3(a)(2) of the Act, or any
savings and loan association or other institution as defined in section
3(a)(5)(A) of the Act whether acting in its individual or fiduciary
capacity; any broker or dealer registered pursuant to section 15 of the
Securities Exchange Act of 1934; any investment adviser registered
pursuant to section 203 of the Investment Advisers Act of 1940 or
registered pursuant to the laws of a state; any insurance company as
defined in section 2(a)(13) of the Act; any investment company
registered under the Investment Company Act of 1940 or a business
development company as defined in section 2(a)(48) of that act; any
Small Business Investment Company licensed by the U.S. Small Business
Administration under section 301(c) or (d) of the Small Business
Investment Act of 1958; any Rural Business Investment Company as
defined in section 384A of the Consolidated Farm and Rural Development
Act; any plan established and maintained by a state, its political
subdivisions, or any agency or instrumentality of a state or its
political subdivisions, for the benefit of its employees, if such plan
has total assets in excess of $5,000,000; any employee benefit plan
within the meaning of the Employee Retirement Income Security Act of
1974 if the investment decision is made by a plan fiduciary, as defined
in section 3(21) of such act, which is either a bank, savings and loan
association, insurance company, or registered investment adviser, or if
the employee benefit plan has total assets in excess of $5,000,000 or,
if a self-directed plan, with investment decisions made solely by
persons that are accredited investors;
* * * * *
(3) Any organization described in section 501(c)(3) of the Internal
Revenue Code, corporation, Massachusetts or similar business trust,
partnership, or limited liability company, not formed for the specific
purpose of acquiring the securities offered, with total assets in
excess of $5,000,000;
* * * * *
(5) Any natural person whose individual net worth, or joint net
worth with that person's spouse or spousal equivalent, exceeds
$1,000,000;
* * * * *
Note 1 to paragraph (a)(5): For the purposes of calculating
joint net worth in this paragraph (a)(5): Joint net worth can be the
aggregate net worth of the investor and spouse or spousal
equivalent; assets need not be held jointly to be included in the
calculation. Reliance on the joint net worth standard of this
paragraph (a)(5) does not require that the securities be purchased
jointly.
[[Page 2613]]
(6) Any natural person who had an individual income in excess of
$200,000 in each of the two most recent years or joint income with that
person's spouse or spousal equivalent in excess of $300,000 in each of
those years and has a reasonable expectation of reaching the same
income level in the current year;
* * * * *
(8) * * *
Note 1 to paragraph (a)(8): It is permissible to look through
various forms of equity ownership to natural persons in determining
the accredited investor status of entities under this paragraph
(a)(8). If those natural persons are themselves accredited
investors, and if all other equity owners of the entity seeking
accredited investor status are accredited investors, then this
paragraph (a)(8) may be available.
(9) Any entity, of a type not listed in paragraphs (a)(1), (a)(2),
(a)(3), (a)(7), or (a)(8), not formed for the specific purpose of
acquiring the securities offered, owning investments in excess of
$5,000,000;
Note 1 to paragraph (a)(9): For the purposes this paragraph
(a)(9), ``investments'' is defined in rule 2a51-1(b) under the
Investment Company Act of 1940 (17 CFR 270.2a51-1(b)).
(10) Any natural person holding in good standing one or more
professional certifications or designations or credentials from an
accredited educational institution that the Commission has designated
as qualifying an individual for accredited investor status. In
determining whether to designate a professional certification or
designation or credential from an accredited educational institution
for purposes of this paragraph (a)(10), the Commission will consider,
among others, the following attributes:
(i) The certification, designation, or credential arises out of an
examination or series of examinations administered by a self-regulatory
organization or other industry body or is issued by an accredited
educational institution;
(ii) The examination or series of examinations is designed to
reliably and validly demonstrate an individual's comprehension and
sophistication in the areas of securities and investing;
(iii) Persons obtaining such certification, designation, or
credential can reasonably be expected to have sufficient knowledge and
experience in financial and business matters to evaluate the merits and
risks of a prospective investment; and
(iv) An indication that an individual holds the certification or
designation is made publicly available by the relevant self-regulatory
organization or other industry body;
Note 1 to paragraph (a)(10): The professional certifications or
designations or credentials currently recognized by the Commission
as satisfying the above criteria will be posted on the Commission's
website.
(11) Any natural person who is a ``knowledgeable employee,'' as
defined in rule 3c-5(a)(4) under the Investment Company Act of 1940 (17
CFR 270.3c-5(a)(4)), of the issuer of the securities being offered or
sold where the issuer would be an investment company, as defined in
section 3 of such act, but for the exclusion provided by either section
3(c)(1) or section 3(c)(7) of such act;
(12) Any ``family office,'' as defined in rule 202(a)(11)(G)-1
under the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-1):
(i) With assets under management in excess of $5,000,000,
(ii) That is not formed for the specific purpose of acquiring the
securities offered, and
(iii) Whose prospective investment is 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; and
(13) Any ``family client,'' as defined in rule 202(a)(11)(G)-1
under the Investment Advisers Act of 1940 (17 CFR 275.202(a)(11)(G)-
1)), of a family office meeting the requirements in paragraph (a)(12)
of this section.
* * * * *
(j) Spousal equivalent. The term spousal equivalent shall mean a
cohabitant occupying a relationship generally equivalent to that of a
spouse.
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
6. The authority citation for part 240 continues to read in part as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602,
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
7. Amend Sec. 240.15g-1 by revising paragraphs (b) and (c) to read as
follows:
Sec. 240.15g-1 Exemptions for certain transactions.
* * * * *
(b) Transactions in which the customer is an institutional
accredited investor, as defined in 17 CFR 230.501(a)(1), (2), (3), (7),
(8), (9), or (12).
(c) Transactions that meet the requirements of Regulation D (17 CFR
230.500 et seq.), or transactions with an issuer not involving any
public offering pursuant to section 4(a)(2) of the Securities Act of
1933.
* * * * *
By the Commission.
Dated: December 18, 2019.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2019-28304 Filed 1-14-20; 8:45 am]
BILLING CODE 8011-01-P