Compliance Issues for RIAs Due to SEC’s New Accredited Investor Definition

March 29, 2021

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The new “accredited investor” definition of the U.S. Securities and Exchange Commission (“SEC”) may raise compliance issues for investment adviser firms (“RIAs”) when supervising personal securities transactions of its investment adviser representatives (“IARs”) who are now be eligible to invest in private placements. 

On August 26, 2020, the SEC adopted amendments to its definition of “accredited investor” which became effective on December 8, 2020. Under the expanded definition, investors can now qualify as an accredited investor and gain access to private placement offerings by demonstrating “defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth.” Certain entities, such as tribal governments, limited liability companies, family offices, and other organizations, can also qualify as accredited investors provided they meet the requirements of the definition. To read the SEC’s Press Release and Fact Sheet on the new definition, click here. The Final Rule is available here.

In a statement regarding the change, SEC Chairman Jay Clayton noted, “[t]he test for individuals to qualify as accredited investors has largely remained unchanged for over 35 years. This test relies exclusively on a person’s income and net worth. If you make enough money or have sufficient assets, you are eligible to participate, and if you do not, you generally are not eligible. The Commission’s use of income or wealth as the exclusive proxy for an individual’s financial sophistication and ability to assess and bear risk has long been unsatisfactory. Individual investors who do not meet the wealth tests, but who clearly are financially sophisticated enough to understand the risks of participating in unregistered offerings, are denied the opportunity to invest in our private markets. . . .[Consequently, w]e are expanding the definition of accredited investor to include an alternative to the wealth test for natural persons — specifically, persons who hold certain professional certifications and designations and other credentials from accredited educational institutions.” (Emphasis added.)  To read the now former Chairman’s full statement, click here.

Accredited Investors Now Include Active IARs

With the SEC’s rule amendment, investment adviser representatives who have passed the Series 65 or Series 66/7 and who maintain an active license are now eligible to qualify as an accredited investor. It is important to note that merely passing the required exams is not sufficient; the individual must meet a “good-standing requirement” and, accordingly, must maintain affiliation with an investment adviser firm. The final rule grants the SEC future flexibility to identify other certifications, designations, or credentials that will qualify an individual as an accredited investor. In such cases, good-standing will also be required.

Supervision of IARs Making Personal Investments in Private Placements

In the event an investment adviser firm permits its investment adviser representatives who are eligible accredited investors to invest in private placements, the chief compliance officer (“CCO”) or designee needs to carefully supervise such personal securities transactions. In particular, the investment adviser firm should require the investment adviser representatives request pre-approval of any personal investment in a private placement offering in accordance with SEC Rule 204A-1.

When reviewing such a request to personally invest in a private placement, the investment adviser firm should analyze whether the private placement offering is limited and the investment adviser representative’s participation in the private placement offering is resulting in an eligible and interested investment advisory client being excluded from participating in the private placement offering.  In other words, the key question for the chief compliance officer  in this situation is whether the investment adviser representative placing his or her personal interests above the client’s interest.

Additional Changes to the Accredited Investor Definition

In addition to including investment adviser representatives with the Series 65 or Series 66/7 in the definition of accredited investor, the final rule also includes several other new categories of individuals and entities that can now qualify as accredited investors. These include:

  • “Knowledgeable employees of private funds” (as defined under Rule 3c-5(a)(4) under the Investment Company Act);
  • Limited liability companies with $5 million in assets, including SEC-registered and state registered investment advisers, exempt reporting advisers, and rural business investment companies;
  • “Family offices” with at least $5 million in assets under management, including their “family clients;”
  • 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, provided that the entity was not formed for the specific purpose of investing in the securities offered.

The rule has also been amended so that “spousal equivalents” (in addition to spouses) may pool their finances for the purpose of qualifying as accredited investors.

SEC Resources

Contact Us

RIA Compliance Consultants encourages investment adviser firms to closely review their supervision of personal securities transactions in light of the SEC’s new accredited investor definition. If your investment adviser firm is an existing client of RIA Compliance Consultants and would like assistance in reviewing your policies and procedures or practices relating to personal securities transactions in private placements, we encourage you to speak with your compliance consultant. Or, if you are not an existing client of RIA Compliance Consultants, click here to set up an introductory call with our Business Development Team.

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