Accredited Investor Definition Changes in 2023?

In January 2023, the Office of Information and Regulatory Affairs for the Securities and Exchange Commission (the SEC) released its 2022 Unified Agenda of Regulatory and Deregulatory Actions, which outlines regulatory actions the SEC is considering in the upcoming months. Below are some of the rules cited in the Unified Agenda as they relate to private placement investment deals, both in “Final Rule” or “Proposed Rule” stages. As a refresher, when the SEC (or other regulatory agencies) elect to make rule changes, they will first propose a rule change and invite public comment before finalizing. Items in the “Final Rule Stage” are those in which the SEC is no longer accepting public input but is moving toward adoption.

The following rules are matters identified in the Proposed Rule Stage for this year:

• The SEC is likely going to propose a rule recommending amendments to Regulation D, including updates to the long standing “accredited investor” definition, as well as amendments to Form D to enhance investor protections.
• The SEC is likely going to recommend rules regarding the use of predicative data analytics, differential marketing, and behavioral prompts for investment advisors and registered broker-dealers.
• The SEC is likely going to recommend enhanced rules regarding registered investment advisors who outsource work to third parties to conduct a due diligence process of the service provider.

The following rules are matters identified in the Final Rule Stage for this year:

• Changes for Registered Investment Advisors; Reporting and Audits. The SEC is likely looking to make significant changes relating to transparency and conflicts of interests disclosures. Many of the rules proposed may require additional quarterly financial statements be provided to investors regarding fees, expenses, and performance issues, as well as providing for annual audits conducted by a third party. While these additional requirements predominantly apply to registered investment advisors (RIAs), it is presently uncertain if these rules will also apply to exempt reporting advisors until the final rule is released.
• Changes for Investment Advisors; Prohibited Activities. The SEC is likely going to change rules regarding prohibited activities and preferential treatments. Unlike reporting and audit rules, these changes are likely to apply to all advisors including exempt reporting advisors as well as those prohibited from registering. This proposal would likely prohibit all private fund advisors from providing preferential terms to certain investors regarding redemptions from the fund or providing preferential information regarding portfolio holdings. In addition, private fund advisors are prohibited from providing preferential terms to certain investors unless disclosed to all current and prospective investors as well, which may be a significant rule change. The SEC’s rationale is likely centered on how these activities have the potential to be “contrary to public interest” and such prohibitions may likely provide additional protections for all investors.

These prohibitions presently may include: 1) charging certain fees and expenses to a private fund or portfolio investments such as fees for unperformed services and fees associated with an examination or investigation of the advisor; 2) Seeking reimbursement, indemnification, exculpation, or limitation of its liability for certain activity; 3) Reducing the amount of an advisor clawback by the amount of certain taxes; 4) Charging fees or expenses on a non pro-rata basis; and 5) Borrowing or receiving an extension of credit from a private fund client.

Proposed Examination Agendas

Additionally, the Division of Examinations of the SEC released its annual examination priorities in early February. The priorities are based on their “four pillars”: (1) promote compliance, (2) prevent fraud, (3) monitor risk, and (4) inform policy.  While the Division looks to continue its examinations under its current framework, there are a few notable new areas of focus in 2023.

One of the new focus areas concerns Registered Investment Advisors to private funds, such as hedge funds, private equity funds, and real estate related funds, specifically focusing on (1) conflicts of interest, (2) calculation and allocation of fees and expenses, (3) compliance with the new Marketing Rule, including performance advertising and compensated testimonials and endorsements, (4) policies regarding the use of alternative data, and (5) compliance with the Advisers Act Rule 206(4)-2, including timely delivery of audited financials. In addition, the Division will focus on RIAs to private funds with specific risk characteristics, like private funds that hold certain hard-to-value investments, such as real estate-connected investments, with an emphasis on commercial real estate.

The rules and examination priorities mentioned in this article specifically concern Private Funds. For more information regarding all SEC Final and Proposed rules, click here. For the full report on Examination Priorities, click here.

Interesting in learning more about this and how it may potentially impact your projects? Contact us today to setup a free consult: adnan@mwfirm.com.

Written by Adnan Merchant and Deepti Nathan. Adnan Merchant is a partner at M&W Law, PLLC, a Dallas-based business law firm. He practices corporate and securities law and focuses on private fund structuring and investment deals, including syndication deals and private equity/venture capital deals. Deepti Nathan is an associate attorney at the firm and practices corporate business and private securities law.

Disclaimer: This article should not be taken as legal advice as each situation can be unique. Please consult your attorney prior to taking any steps. If you do not have an attorney, please feel free to give us a call to set up a consultation.