Accredited Investors, QIBs and Qualified Purchasers

Accredited investor: the Rule 501(a) categories

The accredited investor definition lives in Rule 501(a) and asks one question: does this person need the protections of registration? It is the gatekeeper for Regulation D.

Note first how it is framed. The definition covers any person who comes within a category "or who the issuer reasonably believes comes within" it, at the time of the sale. Reasonable belief is built into the definition itself.

For natural persons there are four routes.

Net worth: individual net worth, or joint net worth with a spouse or spousal equivalent, exceeding one million dollars. The primary residence is excluded as an asset. Indebtedness secured by the primary residence is excluded as a liability up to the estimated fair market value of the residence — but any excess over that value is included as a liability, and so is any increase in that mortgage debt in the 60 days before the sale, unless the increase came from acquiring the residence. That 60-day anti-abuse rule exists because a home equity draw would otherwise convert an illiquid house into countable net worth.

Income: individual income exceeding two hundred thousand dollars in each of the two most recent years, or joint income with a spouse or spousal equivalent exceeding three hundred thousand dollars in each of those years, plus a reasonable expectation of reaching the same level in the current year. Note the arithmetic trap: the joint figure is three hundred thousand, not four hundred thousand, so two people each earning a hundred and eighty thousand qualify jointly and neither qualifies alone.

Professional credential: any natural person holding in good standing a professional certification, designation or credential that the Commission has designated. The Commission has designated three, and they are the securities licences themselves — the Series 7, the Series 65 and the Series 82. Passing the exam this course prepares you for makes you an accredited investor.

Insider status: any director, executive officer or general partner of the issuer, or of a general partner of the issuer. An officer of the company is accredited for that company's offering however modest their means, because the definition is about access to information.

Two further natural-person categories were added in 2020. A "knowledgeable employee" of a private fund, as defined in Investment Company Act Rule 3c-5, is accredited for that fund's securities. And "spousal equivalent" was added throughout, so a cohabitant occupying a relationship generally equivalent to a spouse counts for the joint tests.

Accredited investor: the entity categories

The entity side of Rule 501(a) is a list, and the exam tests the thresholds.

Institutions that are accredited without any asset test at all: banks, savings and loan associations, registered broker-dealers, registered investment advisers and advisers relying on the Section 203(l) or 203(m) exemption, insurance companies, registered investment companies, business development companies, Small Business Investment Companies, and Rural Business Investment Companies.

At five million dollars in total assets: charitable organizations under Internal Revenue Code Section 501(c)(3), corporations, Massachusetts or similar business trusts, partnerships and limited liability companies — each provided it was not formed for the specific purpose of acquiring the securities offered. Also at five million: a trust not formed for that purpose whose purchase is directed by a sophisticated person, and state or local government employee benefit plans.

ERISA plans are accredited in either of two ways: the investment decision is made by a plan fiduciary that is a bank, savings and loan, insurance company or registered investment adviser; or the plan has total assets exceeding five million dollars; or, if self-directed, investment decisions are made solely by accredited investors.

The catch-all added in 2020, Rule 501(a)(9), covers any entity of a type not otherwise listed, not formed for the specific purpose of acquiring the securities, owning INVESTMENTS in excess of five million dollars. Investments, not assets — the term takes its meaning from Investment Company Act Rule 2a51-1(b). This is the category that finally brought Indian tribes, sovereign funds and limited liability companies of unusual shape inside the definition.

Family offices with more than five million dollars under management, not formed for the purpose of the acquisition, whose investment is directed by someone capable of evaluating the merits and risks — and the family clients of such an office — were added at the same time.

And one that reads like a technicality but is not: Rule 501(a)(8) makes accredited any entity in which ALL of the equity owners are accredited investors. You may look through the entity to the natural persons. A three-person LLC formed by three accredited individuals is accredited even with no assets of its own.

One more provision belongs here because it is the arithmetic behind Rule 506(b). Rule 501(e) governs how purchasers are COUNTED, and it excludes from the count any accredited investor, any relative or spouse sharing the purchaser's primary residence, and certain trusts and corporations more than 50 percent owned by the purchaser and those relatives. An entity counts as one purchaser — unless it was organised specifically to acquire the securities and is not itself accredited under 501(a)(8), in which case you count each of its beneficial owners separately. That last clause exists to stop a syndicate of thirty-six non-accredited investors from being papered as a single LLC.

Qualified institutional buyer: the Rule 144A test

A qualified institutional buyer is not a superior grade of accredited investor. It is a different definition, in Rule 144A, doing a different job: it governs RESALES of restricted securities to institutions rather than primary sales by issuers.

The general threshold is that the entity, acting for its own account or the accounts of other QIBs, in the aggregate owns and invests on a discretionary basis at least one hundred million dollars in securities of issuers not affiliated with it. The list of entities eligible on that basis is broad — insurance companies, registered investment companies, employee benefit plans, business development companies, corporations, partnerships, and more.

Three variations are heavily tested.

A registered DEALER qualifies at ten million dollars rather than a hundred million, on the same discretionary basis, excluding any unsold allotment from a public offering it is participating in. Ten million, not a hundred million: this is the single most reliable QIB question.

A registered investment company qualifies if it is part of a FAMILY of investment companies owning at least a hundred million dollars in the aggregate.

A bank or savings and loan association must meet the hundred million dollar test AND have an audited net worth of at least twenty-five million dollars, shown in financial statements dated not more than 16 months before the sale for a domestic institution, or 18 months for a foreign one.

Note what is absent from the whole definition: natural persons. An individual, however wealthy, can never be a QIB.

The rule also tells the seller how to establish status. A seller may rely on the purchaser's most recent publicly available financial statements, on information in filings with a government agency or self-regulatory organisation, on a recognised securities manual — each as of a date within 16 months for a domestic purchaser and 18 for a foreign one — or on a certification from the purchaser's chief financial officer or equivalent officer specifying the amount owned and invested on a discretionary basis. That last route is the QIB certification letter the content outline names in Function 2.2, and it is the one you will actually collect.

Rule 144A also requires the seller to take reasonable steps to ensure the purchaser is AWARE the seller may be relying on the rule.

Qualified purchaser, and why a fund cares

The qualified purchaser lives in the Investment Company Act of 1940, Section 2(a)(51), and its job is to keep a private fund out of registration as an investment company.

A fund that invests in securities is an investment company, and registering as one is incompatible with how private funds operate. Section 3(c) provides two exceptions.

Section 3(c)(1) excepts an issuer whose outstanding securities are beneficially owned by not more than one hundred persons — 250 in the case of a qualifying venture capital fund, a 2018 amendment — and which is not making and does not propose to make a public offering.

Section 3(c)(7) excepts an issuer whose outstanding securities are owned exclusively by QUALIFIED PURCHASERS and which is not making and does not propose to make a public offering. There is no holder limit in 3(c)(7) itself, which is why larger funds use it.

Qualified purchaser thresholds, from Section 2(a)(51): a natural person owning not less than five million dollars in investments; a family company owning not less than five million dollars in investments; and any person, acting for its own account or the accounts of other qualified purchasers, owning and investing on a discretionary basis not less than twenty-five million dollars in investments.

So the ladder, for a natural person, runs: accredited at one million dollars of net worth excluding the home, or two hundred thousand of income; qualified purchaser at five million dollars in investments; and never a QIB at any level.

This matters commercially. A 3(c)(7) fund cannot accept an investor who is accredited but not a qualified purchaser, no matter how much the investor wants in and no matter that Regulation D would allow the sale. Two separate statutes are being satisfied at once, and the fund's exception is the binding one.

Establishing status versus verifying it

The last distinction is the one that decides what lands in your file, and it turns on which branch of Rule 506 the offering uses.

Under Rule 506(b), the standard is the one built into Rule 501(a): the issuer must reasonably believe the purchaser is accredited at the time of sale. In practice that belief is supported by a completed investor questionnaire in which the purchaser represents their status, and by the absence of anything that contradicts it. A representation you have reason to doubt is not a reasonable belief.

Under Rule 506(c), a representation is not enough. The issuer must take reasonable STEPS to verify, and Rule 506(c)(2)(ii) lists five non-exclusive methods for natural persons: reviewing two years of IRS income forms plus a written representation about the current year; reviewing asset documentation dated within the prior three months together with a consumer report covering liabilities; obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant that they verified the person within the prior three months; a certification from a pre-September 2013 investor in the same issuer's 506(b) offering; and a written representation from a person previously verified under one of these methods, good for five years from that verification.

A firm's compliance department will usually route 506(c) verification to the third method, because a written confirmation from a lawyer or accountant keeps the investor's tax returns and bank statements out of the firm's hands. That is a reasonable commercial preference, not a rule.

The representative's role in all of this is not clerical. Function 2.3 of the content outline lists "verification of investor accreditation and sophistication" as a knowledge area, and an investor who is accredited is not thereby suitable. FINRA has said so directly: a customer's status does not relieve the firm of its obligation to determine that the investment is appropriate. Accreditation opens the door. It does not make the recommendation right.