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Trusts as Accredited Investors

Posted in For Investors and Fund Managers, SEC, VC & Private Equity

Perkins, Rachel_Headshot.jpgCONTRIBUTED BY

Rachel M. Perkins
rachel.perkins@dlapiper.com

We often receive questions about the application of the “accredited investor” definition (copied at the end of this post) in Rule 501(a) of Regulation D, and one that’s come up from time to time is how trusts generally qualify as “accredited investors.”  Whether a trust is an “accredited investor” is a fact-specific determination, but generally speaking, the SEC has provided some guidance on trusts in the form of no-action letters and the Compliance and Disclosure Interpretations (“C&DI”).

A revocable trust can be an accredited investor if:

  1. It has more than $5M in assets, it was not formed for the purpose of investing in the fund, and its trustee is a sophisticated person (under Rule 501(a)(7)); OR
  2. The trustee or co-trustee of the trust is a bank, insurance company, registered investment company, business development company, or small business investment company (under Rule 501(a)(1), C&DI Question 255.20, and the Nemo Capital Partners L.P. no-action letter (Mar. 11, 1987)); OR
  3. The trust may be amended or revoked at any time by the grantor(s), the tax benefits of investments made by the trust pass through to the grantor(s), and each grantor is an “accredited investor” (as an entity in which all of the “equity owners” are an accredited investor) (under Rule 501(a)(8), C&DI Question 255.22).

An irrevocable trust can be an accredited investor if:

  1. It has more than $5M in assets, it was not formed for the purpose of investing in the fund, and its trustee is a sophisticated person (under Rule 501(a)(7)); OR
  2. The trustee or co-trustee of the trust is a bank, insurance company, registered investment company, business development company, or small business investment company (under Rule 501(a)(1)); OR
  3. If each grantor is an “accredited investor” and is considered an “equity owner” because the trust has the following characteristics:
  • The trust is a grantor trust for federal income tax purposes and the grantor(s) is the sole funding source; AND
  • The grantor would be taxed on all income of the trust and would be taxed on the sale of trust assets; AND
  • The grantor(s) is the trustee with sole investment discretion; AND
  • The entire amount of the grantor’s contribution plus a rate of return would be paid to the grantor prior to any other payments; AND
  • The trust was established by the grantor for estate planning purposes; AND
  • Creditors of the grantor(s) would be able to reach the grantor’s interest in the trust (under Rule 501(a)(8), C&DI Question 255.25, the Herbert S. Wander no-action letter (Nov. 25, 1983), and the Herrick, Feinstein LLP no-action letter (Jan. 5, 2001)).
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    A “sophisticated person” for the purposes of both paragraphs (1) above is a person who has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of a prospective investment.

    Generally, whether or not the beneficiaries of a conventional trust are accredited investors themselves is not considered in determining whether the trust is accredited.

    Each trust is different, and determining whether a particular trust or investor is accredited is considered on a case-by-case basis. You should consult an attorney regarding your particular situation.

    Rule 501(a) of Regulation D, promulgated under the Securities Act of 1933

    Accredited investor. Accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

    1. Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
    2. Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
    3. Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
    4. Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
    5. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000;
    6. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
    7. Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) and
    8. Any entity in which all of the equity owners are accredited investors.

    • http://www.bonnerlawfirmpc.com Gregory Costanza

      Thank you for the post. I found it helpful in clarifying some of my questions. However, I did notice that your C&DI links are slightly off target. The following link is the right one:

      http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm

      The link you provide refers to sections of the Securities Act, while the appropriate link refers to rules of the Securities Act.

      -GGC