Access to private investments such as venture capital and syndicates is currently limited to “accredited investors”. While the general public is allowed to invest in the stock market, ETFs, and mutual funds, regulations limit access to private investments to only wealthy individuals. Since these types of investments are less regulated and more risky, the theory is that the general public should be protected from these type of risky investments and only wealthy investors who can theoretically afford the losses to invest should be allowed to invest. Generally the SEC defines an “accredited investor” as someone who has earned more than $200,000 annually for the past two years or more than $300,000 combined with their spouse or alternatively people who had an individual or combined net worth of more than $1 million, excluding the value of their home. This clearly excludes a vast majority of the public from having access to investing in private capital markets. These rules have been largely unchanged for over 35 years.
The new rules announced last week expand who is called an “accredited investor.” The SEC has now added several new categories of accredited investors based on financial sophistication rather than simply wealth. Individuals can now “qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution.” Initially, this means brokers with a Series 7, Series 65 or Series 82 licenses. Another category is “knowledgeable employees” of a private investment fund. The SEC says this new expansion is meant to expand “investment opportunities while maintaining appropriate investor protections and promoting capital formation. “
Critics of the “accredited investor” rule point out there is legalized gambling in many parts of the country where people can bet on sports, horses and go to the casino without any income verification, but when it comes to access to potentially high returning investments, only the rich can invest. These new rules are a step in the right direction in opening up private investments to more people.
Overall these changes should be beneficial to the venture capital ecosystem as it brings in more capital to founders, syndicates and venture capital firms.
Highlights from the SEC’s press release:
The amendments to the accredited investor definition in Rule 501(a):
- add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order. In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons. This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future. Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule;
- include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund;
- clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
- add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “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;
- add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and
- 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.
The amendments expand the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition. The amendments also add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.
These new rules will take effect 60 days after publication in the Federal Register. You can read the SEC Press release here. SEC Chairman Jay Clayton issued a statement about his thinking behind the new rules here.
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