SEC changes disclosure rules, redefines 'accredited investors'

By Ken Tysiac

The SEC voted Wednesday to change certain public company disclosures and make more investors eligible to participate in private capital markets as accredited investors.

Public company disclosures of the description of business (Item 101), legal proceedings (Item 103), and risk factors (Item 105) will change after the SEC adopted amendments to Regulation S-K.

The new disclosure requirements are rooted in materiality and designed to facilitate an understanding of each registrant’s business, financial condition, and prospects.

Item 101(a) will be amended by:

  • Making it largely principles-based, requiring disclosure of information material to an understanding of the general development of business.
  • Replacing the previously prescribed five-year time frame with a materiality framework.
  • Permitting a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business, focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference.

Item 101(c) will be amended by:

  • Clarifying and expanding its principles-based approach, with a nonexclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c).
  • Including as a disclosure topic a description of the registrant’s human capital resources to the extent such disclosures would be material to understanding of the registrant’s business.
  • Refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws.

Item 103 will be amended by:

  • Expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure.
  • Implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant to elect to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or 1% of the current assets of the registrant.

Amend Item 105 by:

  • Requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages.
  • Refining the principles-based approach of Item 105 by requiring disclosure of “material” risk factors.
  • Requiring risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.

The amendments will take effect 30 days after publication in the Federal Register.

“Building on our time-tested, principles-based disclosure framework, the rules we adopt today are rooted in materiality and seek to elicit information that will allow today’s investors to make more informed investment decisions,” SEC Chairman Jay Clayton said in a news release. “I am particularly supportive of the increased focus on human capital disclosures, which for various industries and companies can be an important driver of long-term value.”

‘Accredited investors,’ redefined

The SEC’s previous definition of “accredited investor” limited private capital market participation to investors who met specific income or net worth tests.

The amended definition provides eligibility to investors who don’t pass the existing tests for income or net worth but meet defined measures of professional knowledge, experience, or certifications. Holders of SEC Series 7, Series 65, and Series 82 licenses now qualify as accredited investors, and the SEC says members of the public may wish to propose additional certifications, designations, or credentials that satisfy the attributes set out in the new rule.

In addition, the amendments to the accredited investor definition in Rule 501(a):

  • Include as accredited investors, with respect to investments in a private fund, “knowledgeable employees” of the fund.
  • Clarify that limited liability companies (LLCs) with at least $5 million in assets may be accredited investors.
  • Add SEC-and state-registered investment advisers, exempt reporting advisers, and rural business investment companies to the list of entities that may qualify.
  • Add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined under Rule 2a51-1(b) of the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered.
  • Add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act.
  • Add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

An amendment to Rule 215 replaces the existing definition with a cross-reference to the definition in Rule 501(a).

In addition, the amendments expand the definition of “qualified institutional buyer” in Rule 144A to include LLCs and rural business investment companies if they meet the $100 million in securities owned and invested threshold of the definition.

The amendments also add to the list any institutional investors included in the accredited investor definition that are not otherwise enumerated in the definition of “qualified institutional buyer,” provided they satisfy the $100 million threshold.

The SEC also adopted conforming amendments to Rule 163B under the Securities Act and to Rule 15g-1 under the Exchange Act.

Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA’s editorial director.

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