SEC Expands Access to Private Offerings and Streamlines S-K Disclosure

Yesterday, the Securities and Exchange Commission (the SEC) adopted new rules of significance for both private securities offerings and mandatory public company disclosures, in line with key SEC policy initiatives. First, to increase investor access to the expanding private securities markets, the SEC expanded the definition of “accredited investors” to increase the pool of investors eligible to invest in private placements offered by private equity, hedge fund, and other private companies. Second, in line with its emphasis on “principles-based” disclosure, the SEC streamlined aspects of its Regulation S-K disclosure rules to focus disclosure increasingly on materiality assessments specific to each issuer (rather than fixed dollar thresholds). Finally, to aid investor understanding of key business issues, the SEC is also requiring summaries (not exceeding two pages in length) of risk factor sections that exceed 15 pages in length, in response to the concern that risk factor sections, simply by virtue of their length, can obscure important risk disclosures.

The Definition of “Accredited Investor”

Specifically, the SEC expanded the definition of “accredited investor” under Section 501 of the Securities Act of 1933 (the Securities Act) to include persons holding specified professional “certifications, designations, or credentials,” which the SEC may designate from time to time. Accredited investors are permitted to invest in private placements under Regulation D of the Securities Act, and, thus, they have access to the private offerings conducted by private equity, hedge funds, and large private companies. These offerings are practically foreclosed to investors not meeting the qualifications for accredited investor status set forth in Rule 501. The SEC began this regulatory initiative by expanding the definition of “accredited investor” to include holders of stockbrokers’ licenses, including Series 7, Series 65, and Series 82 licenses. The SEC rule change indicates that it may consider adding the holders of other professional certifications to the definition of accredited investors.

The new rule also provided that accredited investors shall include “family offices,” which more than $5 million in assets under management and their “family clients,” as defined in the Investment Advisers Act.^[1] This category has been limited to “companies” with more than $5 million under management.

Finally, the rule also provides that “knowledgeable employees” of investment funds (who are offering the securities) also qualify as accredited investors.^[2] The SEC’s actions were driven by the expansion of private securities markets over recent years, and its desire to allow more investors to participate in them. The SEC noted that last year $2.7 trillion was raised in private securities offerings, more than double the $1.2 trillion raised in public offerings now open to retail investors. Below, this post discusses the rule changes made to the definition of “accredited investor” under Rule 501:

The SEC also adopted amendments to the definition of “qualified institutional buyers” under Rule 144A to expand the lists of entities that are eligible to qualify as qualified institutional buyers, specifically “any institutional accredited investor, as defined in rule 501(a).” The rules avoid inconsistencies between the entity types eligible for each status while continuing to ensure that these entities have sufficient financial sophistication to participate in investment opportunities that do not have the additional protections provided by registration under the Securities Act.

Increased Emphasis on Materiality Assessments in Regulation S-K

Regulation S-K sets forth the body of business and legal disclosures required in SEC periodic reports and prospectuses. The new SEC rules require companies to disclose information material to the development of the business irrespective of a particular time period (e.g., five years). Similarly, the SEC allows a company to devise its own thresholds for disclosures of environmental proceedings rather than over a particular time period, so long as its threshold is low enough to capture material issues and does not exceed the lesser of $1 million or 1% of current assets. This allows companies to essentially fashion for themselves an exemption to current disclosure rules that require disclosure of environmental proceedings with potential sanctions of $100,000 to $300,000.

The new rules also require disclosures of “human capital resources” to the extent material to an understandings of the company’s business.

Summaries of Risk Factor Sections

SEC rules required that public reports and prospectuses include disclosure of “risk factors” applicable to an investment in the company’s securities. These sections have become longer and longer over time, with the result that many exceed 20 pages in length. Obviously, not every risk factor necessarily deserves equal importance in the mind of investors. Accordingly, the SEC has amended its rules to require a company to include a summary of risk factors, not more than two pages in length, whenever its risk factor section exceeds 15 pages in length. To avoid claims that the summary itself is misleading, this new rule will put both companies and their attorneys to the task of identifying the most serious risk factors and highlighting them in the two-page summary. Companies may respond to this new rule by simply shortening their risk factor section to 15 pages.

The following chart describes in further detail each SEC rule change to Regulation S-K:

 

In the SEC’s Open Meeting discussing the changes to Items 101, 103, and 105, many of the commissioners emphasized the new human capital disclosures. Two of the commissioners said they would have required additional disclosures related to human capital, particularly in reference to diversity efforts within companies, as well as climate-related disclosures. In response, Chairman Jay Clayton noted the SEC’s recently issued board diversity disclosure requirements, as well as a prospective ESG-related advisory committee that could provide guidance to the SEC on additional disclosures in the future.

Conclusion

Capital Markets & Securities Law Watch will provide a link to the adoptive amendments relating to the changes to Regulation S-K when they are published by the SEC and will continue to update our blog with additional information as it becomes available.

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^[1] See Rule 275.202(a)(11)(G) of the Investment Advisers Act (“A family office is a company (including its directors, partners, members, managers, trustees, and employees acting within the scope of their position or employment) that: (1) has no clients other than family clients; provided that if a person that is not a family client becomes a client of the family office as a result of the death of a family member or key employee or other involuntary transfer from a family member or key employee, that person shall be deemed to be a family client for purposes of this section for one year following the completion of the transfer of legal title to the assets resulting from the involuntary event; (2) is wholly owned by family clients and is exclusively controlled (directly or indirectly) by one or more family members and/or family entities; and (3) does not hold itself out to the public as an investment adviser.”)

^[2] See SEC, Release No. 33-10824 on Amending the “Accredited Investor” Definition at 11 (the SEC proposed to add “natural persons who are “knowledgeable employees,” as defined in Rule 3c– 5(a)(4) under the Investment Company Act of 1940…of the private-fund issuer of the securities being offered or sold.”)