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Law Firm Recommends Revision to Definition of Reg. D Accredited Investors

The Washington , DC office of Kirkpatrick & Lockhart Nicholson Graham LLP has asked the Advisory Committee on Smaller Public Companies to recommend to the SEC that it include unincorporated governmental entities or instrumentalities, agencies or departments with over $5 million in assets in Regulation D's definition of an accredited investor. The firm noted that a client brought the matter to its attention as an item for the Advisory Committee to address. Unincorporated entities are denied investment opportunities that many similar entities have access to because they fit the current definition of an accredited investor, according to the firm.

Kirkpatrick Lockhart offered as an example the city of Sarasota , Florida , which is not incorporated but has an annual budget exceeding $150 million that is run by sophisticated investment management personnel and advisers. An identical municipal entity that is incorporated would be considered an accredited investor, but Sarasota would not. The firm also noted that an unincorporated entity's employee benefit plan that has over $5 million in assets could be managed by the same personnel as the city and be deemed an accredited investor. To distinguish on the basis of incorporation is a distinction without purpose, according to the firm, and may be nothing more than an "historical accident."

The definition of an accredited investor under Regulation D rule 501(a) includes institutional investors, private business development companies, certain charities and trusts, and employee benefit plans with total assets of $5 million or more that are established and maintained by states and their political subdivisions, instrumentalities, agencies and departments. Kirkpatrick Lockhart pointed out that an unincorporated governmental entity is similar to other investors that fit the accredited investor definition.

Kirkpatrick Lockhart also noted that the CFTC recently adopted a new rule and exempted commodity pool operators and commodity trading advisers from compliance with the disclosure document and certain other requirements if the pool or advice is offered solely to qualified eligible persons. The CFTC borrowed the definition of accredited investor from Regulation D with respect to qualified eligible persons but added unincorporated governmental entities to the definition. The CFTC explained that the definition was intended to reflect persons who possess either the investment expertise necessary to understand the risks involved or that have an investment portfolio of sufficient size to suggest substantial investment expertise and financial sophistication in understanding the risks associated with investing.

Kirkpatrick Lockhart also pointed to a problem posed by rule 506 of Regulation D which permits up to 35 nonaccredited investors per offering. This safe harbor presents problems for unincorporated governmental entities and issuers that continuously offer their securities in reliance on Regulation D, the firm explained. If a nonaccredited investor redeems its interest in a private fund that relies on Regulation D, its space is no longer available for another nonaccredited investor that wishes to invest in the same offering after the redemption. The firm wrote that, since most private fund offerings are continuous, it may be virtually impossible for the private fund to make a new offering in order to obtain 35 more nonaccredited investor spots. The firm also noted that many issuers do not market investment products designed for large, institutional investors to nonaccredited investors because of compliance and integration concerns and the information delivery requirements.

It is unlikely that unincorporated entities will incorporate in order to achieve accredited investor status due to various geographical, political and tax-related reasons, the firm added. Accordingly, on its client's behalf, the firm recommended that the Advisory Committee propose to the SEC an amended definition of accredited investor that tracks the language adopted by the CFTC in defining qualified eligible persons.