23 Aug New rules would expand the definition of “accredited investors"
Earlier this month, the Securities and Exchange Commission proposed long-anticipated, new regulations in defining the requirements of an “Accredited Investor” for purposes of Regulation D (or Reg D) offerings.
If you recall, Reg D refers to certain alternative safe harbor rules promulgated by the SEC that enable a company to sell its securities without registering them. The overwhelming majority of private offerings fall under (or should fall under) one or more rule exemptions under Reg D.
When offering their securities in a private offering of more than $1 million, most companies limit their offerings only to accredited investors because of the compliance requirements, time, and costs associated with offering securities to investors who are not accredited. Under the current regulations, the SEC defines an “accredited investor” as one who fits within one of the following eight categories:
• A bank, insurance company, registered investment company, business development company, or small business investment company.
• An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million.
• A charitable organization, corporation, or partnership with assets exceeding $5 million.
• A director, executive officer, or general partner of the company selling the securities.
• Any business in which all the equity owners are accredited investors.
• A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase.
• A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
• A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
If an individual or entity falls into one or more of these categories, that individual or entity is an accredited investor.
In anticipation of the proposed regulation changes, many feared that the SEC would take an aggressive approach in limiting the number of individuals who would qualify as accredited investors. It was thought, for example, that the SEC might substantially increase the net worth or income requirements. Instead of narrowing the pool of individuals who qualify under the definition however, the SEC has proposed to generally expand it by adding another category of alternative requirements that enable an individual to be considered an accredited investor.
As part of the proposed regulations, the SEC plans to add an “investment owned” category to the ones listed above. The new, alternative proposed requirement is that if an individual and his or her spouse own $750,000 in investments, the individual would meet the accredited investor definition. An individual’s residence and place of business (real estate) cannot be included in the $750,000 total, however.
In addition, the SEC plans to adjust for inflation the dollar threshold amounts listed in its definition. Those same dollar amounts have been in place since 1982. In the last six years (think, dotcom implosion), some people have expressed concerns that the SEC has not modified those amounts for two decades, which in effect has reduced the thresholds in real terms.
As a result, the number of individuals that fit within the definition was substantially greater than the number of individuals who fit within the definition in 1982. And that number is only going to increase over time, with inflation. Under the proposed regulations, the SEC would like to address those concerns by making five-year adjustments to dollar amount thresholds, rounded to the nearest $10,000. The SEC proposes to start these adjustments in 2012.
The “investment owned” and inflationary adjustments are only proposed regulatory changes. The SEC is seeking comments on the proposed regulations until October 9, 2007. The final regulations will then follow, incorporating applicable changes to the existing regulations based on the comments.
As part of the proposed regulations, the SEC also included a new Rule 507 exemption that permits limited advertising to “large accredited investor.” I’ll cover that in a subsequent article.
Previous articles by Matt Storms
• Matt Storms: In pursuit of capital, be sure to track your private offering
• Matt Storms: When raising capital, why use a Private Placement Memorandum?
• Matt Storms: Capital-raising term sheets for angels and venture capitalists
• Matt Storms: Translating the language of capital-raising
• Matt Storms: Securities compliance is part of raising capital
• Matt Storms: Raising capital through placement agents
• Due diligence and corporate clean-up
• Matt Storms: The mechanics of raising capital for your business
• Sarbanes-Oxley for the Rest of Us
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