How is the definition of an accredited investor being expanded?

The proposed rule will amend the definition of an “accredited investor” as follows:

With regard to individuals, the proposed rule would add the term “spousal equivalent” to the definition of a spouse, and give accredited investor status to individuals:

• that have certain professional certifications or designations or other credentials; or
• whose status as a private fund’s “knowledgeable employee.”

With regard to entities, the proposed rule would expand the list of entities, including, but not limited to:

• entities that meet an investments test; and
• family offices with at least $5,000,000 in assets under management and their family clients.

Background

Under the U.S. federal securities laws, a company that offers or sells its securities must register the securities with the Securities and Exchange Commission (“SEC”) or qualify for an exemption from registration.[1] Regulation A+ and crowdfunding provide an exemption from registration that allow the company to raise capital to with unaccredited investors, however, the process for preparing these offering documents can oftentimes be just as burdensome on the company as registering the securities. Rule 506 of Regulation D provides additional exemptions from registration; for these exemptions, we recommend only raising capital from accredited investors. If the SEC is successful in broadening the scope of who is considered to be an accredited investor, more investors will hold accredited investor status, making it easier for private companies trying to raise capital using Rule 506.

What is an accredited investor?

Rule 501 of Regulation D of the Securities Act of 1933 (the “Securities Act”) defines an accredited investor. In summary, an accredited investor is: an individual that has a net worth of $1,000,000, excluding their primary residence; or an individual that has an annual income of $200,000 or more (or $300,000 combines with their spouse) for two years and has a reasonable expectation of meeting those income requirements in the upcoming year. Additionally, Rule 501 defines specific types of entities; and directors, executive officers, or general partners of the issuing company as being accredited.

Public Policy

The SEC depicts the “accredited investor” definition as a central component of Regulation D, stating that it is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”[2] Considering this definition, it’s clear why the SEC would like to expand the definition of an accredited investor 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 the registration under the Securities Act.”[3]

Wilson Bradshaw LLP is a boutique securities law firm in Irvine, California and New York City. We help businesses solicit investors for both public and private companies in a compliant manner. We restrict our practice to securities law, focusing on private and public offerings and SEC enforcement work.

[1] U.S. Securities and Exchange Commission, Accredited Investor, Fast Answers (Nov. 27, 2017), https://www.sec.gov/fast-answers/answers-accredhtm.html.

[2] U.S. Securities and Exchange Commission, Report on the Review of the Definition of “Accredited Investor”, Files (Dec. 18, 2015), https://www.sec.gov/files/review-definition-of-accredited-investor-12-18-2015.pdf.

[3] U.S. Securities and Exchange Commission, 17CFR Parts 230 and 240, Release Nos. 33-10734; 34-87784; File No. S7-25-169, Amending the “Accredited Investor” Definition (Dec. 18, 2019), https://www.sec.gov/files/review-definition-of-accredited-investor-12-18-2015.pdf.

On November 29, 2018, the Securities and Exchange Commission (“SEC”) charged two celebrities with unlawfully touting initial coin offerings (“ICOs”). This is the first time that the SEC has brought touting violation charges involving ICOs. Professional boxer, Floyd Mayweather Jr. and music producer Khaled Khaled, commonly known as DJ Khaled, each received cease and desist orders with the charges.

According to the SEC orders filed November 29, 2018, Mayweather and Khaled did not disclose promotional payments from ICO issuers, including Centra Tech Inc. (“Centra”), and touted on social media accounts to entice potential investors to participate in the offering. Mayweather posted on twitter that Centra’s ICO “starts in a few hours. Get yours before they sell out, I got mine…” This storm hits after the DAO Report in 2017 indicated that ICOs may need to be registered as securities and just a little over a year after the SEC issued an informal warning urging caution around celebrity backed ICOs. Now the SEC is cracking down.

In April 2018, the SEC filed an action against Centra founders alleging that the ICO was fraudulent and parallel criminal charges were brought by the U.S. Attorney’s Office for the Southern District of New York.

Mayweather and Khaled have agreed to pay disgorgment, penalties, and prejudgement interest, totaling just over three-quarters of a million dollars, and agreed to not participate in securities offerings for three and two year periods, respectively.

The SEC’s goal is to encourage promoters to fully disclose to investors that they are being endorsed by the company and not to appear as though they are unbiased investors themselves.

Wilson Bradshaw & Cao, LLP is a boutique securities law firm in Irvine California and New York City. We help businesses solicit investors for both public and private companies in a compliant manner. We restrict our practice to securities law, focusing on private and public offerings and SEC enforcement work.

The Securities and Exchange Commission (“SEC”) charged two companies, CarrierEQ Inc. (“Airfox”) and Paragon Coin Inc., (“Paragon”) who conducted Initial Coin Offerings (“ICOs”) after the SEC published its famous DAO Report of Investigation concerning the topic of ICOs.

On November 16, 2018, after an undisclosed investigation period by the SEC, two orders by the SEC forcing Airfox and Paragon to Cease and Desist their ICOs and register their tokens as securities. However, there is no guarantee that such tokens will ever make it through the registration process.

Airfox raised $15 million worth of digital assets to finance its development of a token “ecosystem” where they would start a mobile application that would create a market that would allow users to interact with advertisers. Airfox targeted users in developing countries.

Paragon raised $12 million to add blockchain technology to the cannabis industry to further legalize cannabis and related products.

As is customary with ICOs, the SEC alleges that neither company registered their tokens as securities, nor did they fit an exemption. Both companies paid $250,000 in penalties and the orders included undertakings to compensate any investors who may have been harmed as a result of purchasing tokens in the offerings.

How could Airfox and Paragon have conducted their ICOs legally? By registration, of course. How does that work? The law is still unclear. However, there has only been one ICO registration case where the SEC decided that there was no fraudulent intent, which is Munchee, Inc. The Commission did not impose a penalty or include undertakings from Munchee, which stopped its offering before delivery of tokens and returned all proceeds to the investors. The SEC highlights Munchee, Inc. as a virtuous ICO, since they disgorged their proceeds to the investors. This result is not promising.

If you would like to raise capital, then contact Wilson Bradshaw & Cao, LLP so you can raise capital in a compliant manner. We restrict our practice to securities law, in particular private and public offerings and SEC enforcement work.