THE EXPANDED DEFINITION OF ACCREDITED INVESTOR: A (FIRST) STEP IN THE RIGHT DIRECTION

For all the ink spilled wondering and worrying how the SEC might change the definition of accredited investor, yesterday’s announcement seems almost anti-climactic.

Perhaps the main story is what the SEC didn’t do. It didn’t limit the definition of accredited investor in any way. Everyone who was an accredited investor yesterday is an accredited investor today. In that sense the SEC continues to demonstrate its support for the private investment marketplace and give the lie to those who believe otherwise.

On the other hand, the SEC didn’t break much new ground expanding the definition, at least for now.

The principal expansion, as expected, was in adding to the list of accredited investors individuals who hold Series 7, Series 65, or Series 82 licenses. The SEC also added investment advisers registered with the SEC or any state and, more surprisingly, venture capital fund advisers and exempt reporting advisers. I say “more surprisingly” because neither venture capital fund advisers nor exempt reporting advisers are required to pass exams or otherwise demonstrate financial knowledge or sophistication.

The list of accredited investors was also extended to include:

  • Entities, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that (1) own “investments” (as defined in Rule 2a51-1(b) under the Investment Company Act of 1940) in excess of $5 million, and (2) were not formed to invest in the securities offered;
  • Rural business development companies;
  • 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 of 1940; and
  • Knowledgeable employees of a private fund, but only with respect to investments in that fund.

Finally, the SEC clarified that existing provisions of the accredited investor definition that refer to spouses also includes “spousal equivalents,” meaning someone who has gotten under your nerves for at least seven years (actually “a cohabitant occupying a relationship generally equivalent to that of a spouse”).

While a modest first step, these additions are welcome and a harbinger of bigger things to come. The new rule explicitly invites FINRA, other industry self-regulatory authorities, and accredited education institutions to develop “certifications, designations, or credentials” that the SEC would approve for accredited investor qualification. I imagine FINRA and professional organizations will jump at the chance. If this leads to millions or tens of millions of Americans learning about securities and participating in the Crowdfunding market, well, that’s a very good thing for everyone.

The new definition will become effective 60 days after being published in the Federal Register.

SEC ISSUES EMERGENCY RULES TO FACILITATE TITLE III CROWDFUNDING DURING COVID-19 CRISIS

With credit markets tightened and 30 million Americans newly out of work, the SEC has adopted temporary rules to make Title III Crowdfunding a little easier from now until August 31, 2020.

The temporary rules are available here. They aim to make Title III a little faster and easier in four ways:

#1 – Launch Offering without Financial Statements

An issuer can launch the offering – go live on a funding portal – before its financial statements are available. (But investment commitments aren’t binding until the financial statements have been provided.)

#2 – Lower Standard for Some Financial Statements

An issuer trying to raise between $107,000 and $250,000 in a 12-month period doesn’t have to produce financial statements reviewed by an independent accountant, only financial statements and certain information from its tax return, both certified by the CEO.

#3 – Quicker Closing

An issuer can close the offering as soon as it has raised the target offering amount, even if the offering hasn’t been live for 21 days, as long as the closing occurs at least 48 hours after the last investment commitment and the funding portal notifies investors of the early closing.

#4 – Limit on Investor Cancellations 

Investors can cancel within 48 hours of making a commitment, but can’t cancel after that unless there’s a material change in the offering.

CAVEAT:  These rules are not available if the issuer:

  • Was organized or operating within six months before launching the offering (e., this is not for brand-new companies); or
  • Previously raised money using Title III Crowdfunding but failed to comply with its obligations.

I’m not sure how much difference these rules will make in practice. But that’s not the main point as far as I’m concerned. The main point is that with about a million other things on its plate, the SEC took the time to think about and draft these rules. The SEC must believe that equity Crowdfunding can play an important role in our capital markets.

On that basis, I predict that the proposals the SEC made on March 4th will be adopted soon after the public comment period expires on June 1st. And after that, who knows.

SEC PROPOSES MAJOR UPGRADES TO CROWDFUNDING RULES

The SEC just proposed major changes to every kind of online offering:  Rule 504, Rule 506(b), Rule 506(c), Regulation A, and Regulation CF.

The proposals and the reasoning behind them take up 351 pages. An SEC summary is here, while the full text is here. The proposals are likely to become effective in more or less their existing form after a 60-day comment period.

I’ll touch on only a few highlights:

  • No Limits in Title III for Accredited Investors:  In what I believe is the most significant change, there will no longer be any limits on how much an accredited investor can invest in a Regulation CF offering. This change eliminates the need for side-by-side offerings and allows the funding portal to earn commissions on the accredited investor piece. The proposals also change the investment limits for non-accredited investor from a “lesser of net worth or income” standard to a “greater of net worth or income” standard, but that’s much less significant, in my opinion.
  • Title III Limit Raised to $5M:  Today the limit is $1.07M per year; it will soon be $5M per year, opening the door to larger small companies.

NOTE:  Those two changes, taken together, mean that funding portals can make more money. The impact on the Crowdfunding industry could be profound, leading to greater compliance, sounder business practices, and fewer gimmicks (e.g., $10,000 minimums).

  • No Verification for Subsequent Rule 506(c) Offerings:  In what could have been a very important change but apparently isn’t, if an issuer has verified that Investor Smith is accredited in a Rule 506(c) offering and conducts a second (and third, and so on) Rule 506(c) offering, the issuer does not have to re-verify that Investor Smith is accredited, as long as Investor Smith self-certifies. But apparently the proposal applies only to the same issuer, not to an affiliate of the issuer. Thus, if Investor Smith invested in real estate offering #1, she must still be verified for real estate offering #2, even if the two offerings are by the same sponsor.
  • Regulation A Limit Raised to $75M:  Today the limit is $50M per year; it will soon be $75M per year. The effect of this change will be to make Regulation A more useful for smaller large companies.
  • Allow Testing the Waters for Regulation CF:  Today, a company thinking about Title III can’t advertise the offering until it’s live on a funding portal. Under the new rules, the company will be able to “test the waters” like a Regulation A issuer.

NOTE:  Taken as a whole, the proposals narrow the gap between Rule 506(c) and Title III. Look for (i) Title III funding portals to broaden their marketing efforts to include issuers who were otherwise considering only Rule 506(c), and (ii) websites that were previously focused only on Rule 506(c) to consider becoming funding portals, allowing them to legally receive commissions on transactions up to $5M.

  • Allow SPVs for Regulation CF:  Today, you can’t form a special-purpose-vehicle to invest using Title III. Under the SEC proposals, you can.

NOTE:  Oddly, this means you can use SPVs in a Title III offering, but not in a Title II offering (Rule 506(c)) or Title IV offering (Regulation A) where there are more than 100 investors.

  • Financial Information in Rule 506(b):  The proposal relaxes the information that must be provided to non-accredited investors in a Rule 506(b) offering. Thus, if the offering is for no more than $20M one set of information will be required, while if it is for more than $20 another (more extensive) set of information will be required.
  • No More SAFEs in Regulation CF:  Nope.

NOTE:  The rules says the securities must be “. . . . equity securities, debt securities, or securities convertible or exchangeable to equity interests. . . .” A perceptive readers asks “What about revenue-sharing notes?” Right now I don’t know, but I’m sure this will be asked and addressed during the comment period.

  • Demo Days:  Provided they are conducted by certain groups and in certain ways, so-called “demo days” would not be considered “general solicitation.”
  • Integration Rules:  Securities lawyers worry whether two offerings will be “integrated” and treated as one, thereby spoiling both. The SEC’s proposals relax those rules.

These proposals are great for the Crowdfunding industry and for American capitalism. They’re not about Wall Street. They’re about small companies and ordinary American investors, where jobs and ideas come from.

No, the proposals don’t fix every problem. Compliance for Title III issuers is still way too hard, for example. But the SEC deserves (another) round of applause.

Please reach out if you’d like to discuss.