Recently, Pastore & Dailey advised clients on a unique issue related to accredited investors. The client, an SEC registered investment advisor, asked Pastore & Dailey whether the death of an accredited investor had any legal implications for the funds it manages when the accredited investor bequeathed his investment to a non-accredited investor. The simple answer is no.
Under the securities laws, the term “sale” is defined as to include every contract of sale or disposition of a security or interest in a security, for value. Additionally, the term “offer to sell”, “offer for sale”, or “offer” is defined to include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value. 15 U.S.C. § 77b(a)(3).
Thus, an involuntary transfer by operation of law, such as a divestment of an investment upon death to beneficiaries will not be considered a “sale” or an “offer to sell.” Therefore, the recipient is not required to be an accredited investor.
Special Rule for Family Offices
Pastore & Dailey also advised the client on the legal implications of this unique circumstance when the accredited investor is a family office.
An accredited investor now includes any family office as defined in Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (“Advisers Act”): (i) with assets under management in excess of $5,000,000, (ii) that is not formed for the specific purpose of acquiring the securities offered, and (iii) whose prospective investment is directed by a person who has such knowledge and experience in financial and business matters that such family office is capable of evaluating the merits and risks of the prospective investment. 17 C.F.R. § 230.51(a)(12).
The accredited investor definition was also expanded to include a family client, as defined in Rule 202(a)(11)(G)-1 under the Advisers Act. A family client as defined in Rule 202(a)(11)(G)-1 is: (i) Any family member; (ii) Any former family member; or (vi) Any estate of a family member, former family member or key employee. 17 C.F.R. § 275.202(a)(11)(G)-1(d)(4).
In the Adoption Release, the SEC explained that it is not excluding from the accredited investor definition a beneficiary that temporarily qualifies as a family client under the family office rule. Thus, a beneficiary who receives the stocks from the decedent will be considered a family client for purposes of the accredited investor definition for exactly one year. SEC Release No. 33-10824, August 26, 2020.
There are limitations to this rule. Although a beneficiary would not be required to unwind any of the securities received in an involuntary transfer, the beneficiary would not be considered an accredited investor in connection with the purchase of additional securities, unless the beneficiary qualified as an accredited investor on another basis.[1]
In conclusion, the requirement that an offering or sale of restricted securities be made to an accredited investor applies at the “time of sale of the securities to that person.” Thus, an involuntary transfer such as a divestment of shares to a beneficiary upon death of the accredited investor should not pose a problem for a testator and their funds.
Summary
As the requirement that an offering or sale of restricted securities be made to an accredited investor applies at the “time of sale of the securities to that person,” a involuntary transfer, such as a divestment of shares to a beneficiary upon death of the accredited investor should not pose a problem for an RIA and its funds.
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[1] SEC Expands the “Accredited Investor” and “QIB” Definitions and the Permitted Scope of “Testing the Waters.” Proskauer. September 9, 2020. https://www.proskauer.com/alert/sec-expands-the-accredited-investor-and-qib-definitions-and-the-permitted-scope-of-testing-the-waters#_ftnref3
