Marijuana-related businesses (“MRBs”) planning to raise money in private offerings should be aware of recent changes to the “accredited investor” definition under the Securities Act of 1933, as amended (“Securities Act”). The U.S. Securities and Exchange Commission (“SEC”) recently adopted a final rule (the “Final Rule”) amending Rule 501(a) of Regulation D promulgated under the Securities Act, which expands the definition of “accredited investor.”
Topline conclusion: These changes establish additional investor eligibility qualifications, thereby increasing the available pool of potential investors who may participate in private securities offerings. This is good news for MRBs hoping to raise money, particularly under Rule 506(b) or Rule 506(c).
When will these changes become effective? The Final Rule will become effective sixty (60) days following its publication in the Federal Register. It is anticipated that the effective date will be sometime in early November 2020.
Will the Final Rule change the income and net worth standards required for individuals? No. The income and net worth thresholds for individuals remain the same. That is, individuals must still have an annual income of at least $200,000 (or $300,000, together with his/her spouse) or a net worth of more than $1 million (excluding the value of their residence).
Below is a summary of some of the more significant features of the Final Rule, and its impact on investors who are natural persons and entities.
- Professional Certifications, Designations, or Other Credentials. The Final Rule adds a new category that permits natural persons to qualify as accredited investors based on certain professional certifications, designations, or other credentials that the SEC may designate from time to time by order. The Final Rule provides the SEC with the flexibility to reevaluate or add certifications, designations, or credentials in the future. In conjunction with the adoption of the Final Rule, the SEC designated by order holders in good standing of the following Financial Industry Regulatory Authority, Inc. licenses:
- Series 7: Licensed General Securities Representative:
- Series 65: Licensed Investment Adviser Representative; and
- Series 82: Licensed Private Securities Offerings Representative.
“Knowledgeable Employees” of Private Funds. With respect to investments in private funds, the Final Rule allows “knowledgeable employees” (as defined in Rule 3c-5 under the Investment Company Act of 1940, as amended (the “Investment Company Act”)) of a private fund (e,g, hedge funds, private equity funds, and venture capital funds) to qualify as accredited investors to invest in the private fund. Generally, persons who are “knowledgeable employees” include executive officers, directors, trustees, general partners, or persons serving in a similar capacity, or employees or affiliated management persons of such fund (other than fund employees performing solely clerical, secretarial, or administrative functions) who, in connection with their regular functions, have participated in a fund’s investment activities for at least 12 months.
- Spousal Equivalents. The Final Rule adds the term “spousal equivalent” to the accredited investor definition. The result is that natural persons who are “spousal equivalents” (defined as “a cohabitant occupying a relationship generally equivalent to that of a spouse”) may now pool their finances together to satisfy the accredited investor requirements.
- Limited Liability Companies. The Final Rule codifies the long-standing position held by the SEC’s staff that limited liability companies (“LLCs”) with greater than $5 million in total assets that were not established for the specific purpose of acquiring the securities being offered may be accredited investors. In the SEC’s release commentary, it considered including managers of qualified LLCs as automatically qualified accredited investors, but ultimately opted declined to do so. However, the SEC offered its interpretation that managers of LLCs may still qualify as accredited investors through their status as an “executive officer.”
- Investment Advisers and RBICs. The Final Rule adds SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (“RBICs”) to the list of entities that may qualify as accredited investors;
- Family Offices and Family Clients. Qualified “family offices” with at least $5 million in assets under management and their “family clients” (as each of those terms is defined under the Investment Advisers Act of 1940, as amended), are now eligible for accredited investor status under the Final Rule. The family office must not have been formed specifically for the purpose of acquiring the offered securities, and the prospective investment(s) is/are must be directed by a person having such knowledge and experience in financial and business matters that the family office is capable of evaluating the merits and risks of the prospective investment(s).
- Catch-All for Other Entities. A new “catch-all” category is established under the Final Rule for entities that own investments of more than $5 million that were not formed for the specific purpose of acquiring the offered securities. This category includes 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.
- Entity Ownership Look-Through. The Final Rule clarifies that an issuer may look through various forms of equity ownership to the ultimate natural persons in determining accredited investor status under Rule 501(a)(8) (e., an entity of which all equity owners are accredited investors). If all those natural persons are themselves accredited investors, the requirements of Rule 501(a)(8) would be satisfied.
The amendments under the Final Rule are consistent with the SEC’s “broader effort to simplify, harmonize, and improve the exempt offering framework under the Securities Act to promote capital formation and expand investment opportunities while maintaining and enhancing appropriate investor protections.” The expectation is that the expansion of the potential accredited investor pool will result in increased funding available to companies seeking to raise money through private offerings.
Once the Final Rule becomes effective, MRBs raising money through private placements (e.g., exempt offerings under Rules 506(b) and 506(c)) are advised to review and make any necessary updates to their subscription documents in order to address these changes. MRBs should pay particular attention to any updates to their accredited investor questionnaires that may be necessary as a result of the Final Rules.
Finally, MRBs raising money in reliance on Rule 506(c) exemption will need to consider if – and how – the expanded “accredited investor” categories might impact the steps they should take to verify investor qualifications, including the types of documentation that may be necessary to collect from prospective investors.