Regulation D Rule 501(a)(8) Inquiry

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Regulation D Rule 501(a)(8) Inquiry

A potential client asked me whether their LLC would be deemed to be accredited under Regulation D Rule 501(a)(8) (“[a]ny entity in which all of the equity owners are accredited investors”) if the only members of the LLC were the client (an individual) and his mom (also an individual)?  His mom qualified as accredited under Rule 501(a)(5) (net worth of at least $1 million (excluding her home)), but the potential client did not.  The potential client actually read through Rule 501, however, and keenly noticed Rule 501(a)(4), which rule qualifies any executive officer or director of the “issuer of the securities being offered or sold” as an accredited investor.  The client wanted to form the LLC with the client’s mom, serve as the manager of the LLC, invest through the LLC and qualify the LLC as an accredited investor under Rule 501(a)(8).

Here is the answer.  If my potential client’s LLC does not qualify as an accredited investor under Rule 501(a)(1) (at least $5 million of total assets), and one of the LLC’s members (i.e., the potential client) qualifies as accredited only under Rule 501(a)(4) (any executive officer or director of the “issuer of the securities being offered or sold”) but not under Rule 501(a)(5) (an individual with a $1 million net worth (excluding value of principal residence) or $200,000 of income ($300,000 with spouse), under the SEC’s Interpretive Release 33-6455, the LLC itself will not qualify as an accredited investor under Rule 501(a)(8) (“[a]ny entity in which all of the equity owners are accredited investors”).

Here is the text of the interpretive release:

Entities Owned By Accredited Investors–Rule 501(a)(8)

Any entity in which each equity owner is an accredited investor . . . is accredited under Rule 501(a)(8).

(24) Question: All but one of the shareholders of a corporation are accredited investors by virtue of net worth or income. The unaccredited shareholder is a director who bought one share of stock in order to comply with a requirement that all directors be shareholders of the corporation. Is the corporation an accredited investor under Rule 501(a)(8)?

Answer: No. Rule 501(a)(8) requires “all of the equity owners” to be accredited investors. The director is an equity owner and is not accredited. Note that the director cannot be accredited under Rule 501(a)(4). That provision extends accreditation to a director of the issuer, not of the investor.

Similar language is included in the SEC’s Division of Corporation Finance Manual of Publicly Available Telephone Interpretations.  This answer is saying that Rule 501(a)(4) can make my client an accredited investor with respect to the LLC, but the LLC can’t turn around and say that all of its equity owners are accredited.  This is the case because one of the LLC’s owners, my client, is only accredited under Rule 501(a)(4), and “[t]hat provision extends accreditation to [the] director of the issuer [i.e., the LLC], not of the investor [i.e., again, the LLC, but in its role as investor rather than issuer of securities.]

Interestingly, the next question in this interpretive release reads as follows:

(25) Question: Who are the equity owners of a limited partnership?

Answer: The limited partners.

By this reasoning, the general partner would not be deemed to be an equity owner and thus my client could form a limited partnership instead.  My client could own an LLC that would serve as the general partner of the partnership, and under this interpretive release, the only equity owners are the limited partners.  In that case, as long as the limited partners are accredited, the ownership by my client of an interest in the LLC (as general partner) seems not to disturb the status of the partnership as accredited.  Go figure!