Loophole in Angel Investor Amendment: No 4-Year Review of Reg D “Accredited Investor” Definition After All?

by William Carleton, Joe Wallin and Marcus Williams

Is there a loophole in the “Angel Investor Amendment” just passed this week by the Senate? If so, was it intended, or does it reflect a last-minute mistake?

There are different definitions of “accredited investor” at issue here. One applies to securities offerings that are exempt from registration requirements under Section 4(6) of the Securities Act. Another applies to Reg D offerings, which fall under the Securities Act Section 4(2). Although Section 4(6) exempts offerings that are made exclusively to accredited investors, startups don’t use it, in part because offerings under that exemption are limited to $5,000,000, and in part because an issuer relying on that exemption must also perfect a state Blue Sky exemption or undergo merit review by the securities commissioner in each state in which the offering takes place.

To put a point on it, the “accredited investor” definition that is used for Reg D offerings is the one that matters to startups.

Well, as we previously reported (in a post published both here on Joe’s blog and here on Bill’s blog), the amendment that saved startup seed financing and angel investing in America, passed in the Senate by voice vote on May 17, 2010 (SA 4056), changed only slightly from what Senator Bond of Missouri had introduced the prior week (SA 4037).

But one of those slight changes was to suddenly distinguish between the “accredited investor” definition for purposes of 4(6) offerings, and the “accredited investor” definition under Reg D. Sen. Bond’s prior amendment made no such distinction; it treated both definitions in the same way.

Alan Parness pointed this out on Broc Romanek’s blog:

“Section 412(b)(2) [in SA 4056, the version of the amendment that actually passed,] mandates that the SEC undertake reviews of the definition every 4 years thereafter, but solely as regards the definition of the term in 17 CFR Sec. 230.215 (Rule 215 under the ’33 Act for purposes of the definition of “accredited investor” in Section 2(a)(15)(ii) and, in turn, the Section 4(6) exemption), but not as regards the definition in Rule 501(a) of Reg. D. The version of Section 412 in SA 4037 made no such distinction between the rules.”

In short, whether intentionally or by mistake, the financial regulatory reform bill passed by the Senate does NOT appear to require a review of the Reg D accredited investor definition every four years — only of the definition that applies to the Section 4(6) exemption.

Here’s a summary of precisely what the amendment does, with respect to the Reg D accredited investor definition:

mandates an immediate change in both accredited investor definitions, to exclude the value of one’s principal residence from the net worth threshold of $1 million;
contemplates (but does not require) that the SEC may review the definition as a whole (including, presumably, the annual income requirements); and
requires that there be no adjustments to any accredited investor definition that raise the net worth threshold in excess $1 million, less the value of one’s principal residence, for a period of four years.

We are staying tuned to see if the House-Senate conference committee revisits this distinction.

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