What is an Accredited Investor or a Qualified Institutional Investor Anyway?

ABA Journal’s 10th Annual Blawg 100

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Title II of the JOBS Act provides that the SEC will amend Section 4(2) of the Securities Act of 1933 and Regulation D promulgated there under, to eliminate the prohibition on general solicitation and general advertising in a Rule 506 offering, so long as all purchasers in such offering are accredited investors. The JOBS Act directs the SEC to make the same amendment to Rule 144A so long as all purchasers in the Rule 144A offering are qualified institutional buyers.  Neither a Rule 506 offering nor a Rule 144A offering will be considered a public offering (i.e. will lose its exemption) by virtue of a general solicitation or general advertising so long as the issuer has taken reasonable steps to verify that purchasers are either accredited investors or qualified institutional buyers, respectively.  Since it would be impossible to ensure that only accredited investors, or qualified institutional buyers, receive, review or become aware of general solicitations and advertisements, the rule focuses on ensuring that the purchasers qualify.

It is anticipated that the rulemaking will focus on determining accredited status and the comment letters submitted to the SEC in advance of rule-making have all basically concentrated on that issue.  It is easy for us practitioners to assume that the public knows what makes an investor accredited or an institution qualified and that they can tell you their status.  However, based on how many times I am asked the question, well, we all know what they say about assumptions…

So qualifying as either an accredited investor or qualified institutional buyer is a straight line, non-discretionary test.  You either do or don’t qualify (like your tax bracket…).

Below is the test for each.

Accredited Investor Test

Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

1. Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
2. Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
3. Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
4. Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
5. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000, not including their principal residence;
6. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
7. Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) and
8. Any entity in which all of the equity owners are accredited investors.

Qualified Institutional Investor

Qualified institutional buyer shall mean:

1. Any of the following entities, acting for its own account or the accounts of other qualified institutional buyers, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity:
   1. Any insurance company as defined in section 2(a)(13) of the Act ;
      Note: A purchase by an insurance company for one or more of its separate accounts, as defined by section 2(a)(37) of the Investment Company Act of 1940 (the “Investment Company Act”), which are neither registered under section 8 of the Investment Company Act nor required to be so registered, shall be deemed to be a purchase for the account of such insurance company.
   2. Any investment company registered under the Investment Company Act or any business development company as defined in section 2(a)(48) of that Act;
   3. Any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958;
   4. Any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees;
   5. Any employee benefit plan within the meaning of title I of the Employee Retirement Income Security Act of 1974;
   6. Any trust fund whose trustee is a bank or trust company and whose participants are exclusively plans of the types identified in paragraph (a)(1)(i)(D) or (E) of this section, except trust funds that include as participants individual retirement accounts or H.R. 10 plans.
   7. Any business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
   8. Any organization described in section 501(c) (3) of the Internal Revenue Code, corporation (other than a bank as defined in section 3(a)(2) of the Act or a savings and loan association or other institution referenced in section 3(a)(5)(A) of the Act or a foreign bank or savings and loan association or equivalent institution), partnership, or Massachusetts or similar business trust; and
   9. Any investment adviser registered under the Investment Advisers Act.

1. Any dealer registered pursuant to section 15 of the Exchange Act, acting for its own account or the accounts of other qualified institutional buyers, that in the aggregate owns and invests on a discretionary basis at least $10 million of securities of issuers that are not affiliated with the dealer, Provided, That securities constituting the whole or a part of an unsold allotment to or subscription by a dealer as a participant in a public offering shall not be deemed to be owned by such dealer;
2. Any dealer registered pursuant to section 15 of the Exchange Act acting in a riskless principal transaction on behalf of a qualified institutional buyer;Note: A registered dealer may act as agent, on a non-discretionary basis, in a transaction with a qualified institutional buyer without itself having to be a qualified institutional buyer.
3. Any investment company registered under the Investment Company Act, acting for its own account or for the accounts of other qualified institutional buyers, that is part of a family of investment companies which own in the aggregate at least $100 million in securities of issuers, other than issuers that are affiliated with the investment company or are part of such family of investment companies. Family of investment companies means any two or more investment companies registered under the Investment Company Act, except for a unit investment trust whose assets consist solely of shares of one or more registered investment companies, that have the same investment adviser (or, in the case of unit investment trusts, the same depositor), Provided That, for purposes of this section:
   1. Each series of a series company (as defined in Rule 18f-2 under the Investment Company Act ) shall be deemed to be a separate investment company; and
   2. Investment companies shall be deemed to have the same adviser (or depositor) if their advisers (or depositors) are majority-owned subsidiaries of the same parent, or if one investment company’s adviser (or depositor) is a majority-owned subsidiary of the other investment company’s adviser (or depositor);

1. Any entity, all of the equity owners of which are qualified institutional buyers, acting for its own account or the accounts of other qualified institutional buyers; and
2. Any bank as defined in section 3(a)(2) of the Act, any savings and loan association or other institution as referenced in section 3(a)(5)(A) of the Act, or any foreign bank or savings and loan association or equivalent institution, acting for its own account or the accounts of other qualified institutional buyers, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it and that has an audited net worth of at least $25 million as demonstrated in its latest annual financial statements, as of a date not more than 16 months preceding the date of sale under the Rule in the case of a U.S. bank or savings and loan association, and not more than 18 months preceding such date of sale for a foreign bank or savings and loan association or equivalent institution.

The Author

Attorney Laura Anthony,
Founding Partner, Legal & Compliance, LLC
Securities, Reverse Mergers, Corporate Transactions

Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the over the counter market including the OTCBB and OTCQB. For almost two decades Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

Ms. Anthony’s focus includes but is not limited to crowdfunding, registration statements, PIPE transactions, private placements, reverse mergers, and compliance with the reporting requirements of the Securities Exchange Act of 1934 including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SRO’s such as FINRA and DTC for corporate changes such as name changes, reverse and forward splits and change of domicile.

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