To New York Businesses and Others Raising Capital—“Sophisticated Investors” not Same Thing as “Accredited Investors”
The term “accredited investor” is ubiquitous when companies (across industries, entertainment, technology, manufacturing, importing, etc.) are raising capital through private placements/offerings. However, the term “sophisticated investor” is often bandied about, and too often it is used interchangeably with “accredited investor”. And that is a grave mistake.
For many private offerings (i.e., those seeking registration exemption under federal rules 504 and 505), the distinction is mostly irrelevant. However, for any business that seeks to raise more than 5 million dollars or seeks to bypass the state Blue Sky rules, it will have to avail itself of rule 506. And that rule makes very clear that the subject investors not only be “accredited” but they be “sophisticated” as well. Hence a business that takes funds from merely accredited investors and not accredited and sophisticated investors will violate rule 506 and possibly lose its exemption.
“Sophisticated” in the simplest sense means an investor who has experience in investing. The official definition is one: “who has the sufficient experience and knowledge of the financial markets, and is able to evaluate a particular investment on its merits.” And that roughly boils down to a case by case analysis depending on both the nature of the securities sold and the contours of the investment within that particular industry or sector. However, this is not always an easy determination, since the definition is almost entirely qualitative and as the recent $550MM Goldman settlement with the SEC illustrates (there, the SEC alleged Goldman did not provide its investors enough info on subprime instruments, despite Goldman’s assertion these investors were “sophisticated.”)
All businesses raising capital under rule 506 should not only have their investors contractually represent that they are sophisticated, but should also take care to provide reasonable disclosure documents so as not end up in the same situation as Goldman.
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