Qualified Purchaser

A qualified purchaser is a person who meets the wealth test in section 2(a)(51) of the Investment Company Act of 1940. For a natural person the test is owning "not less than $5,000,000 in investments", as the SEC defines investments by rule; other clauses cover certain family companies at the same threshold, certain trusts, and any person who owns and invests on a discretionary basis at least $25,000,000 in investments for its own account or for other qualified purchasers. The status matters for one reason above all others: a private fund relying on section 3(c)(7) may admit an unlimited number of investors provided every one of them is a qualified purchaser.

The phrase also appears in an entirely unrelated place, and a reader who carries one meaning into the other will get the answer backwards. Under Securities Act section 18(b)(3) a security is a covered security, and so outside state registration requirements, when it is sold to "qualified purchasers" as the SEC defines them by rule. The SEC's rule for Regulation A, 17 CFR 230.256, defines a "qualified purchaser" for that purpose as "any person to whom securities are offered or sold pursuant to a Tier 2 offering of this Regulation A". That is not a wealth test. It is everyone in the offering. The two definitions live in two statutes and do two different jobs, and the Securities Act expressly authorizes the difference.

Four clauses, not one number. Section 2(a)(51)(A) reaches, in order: a natural person who owns not less than $5,000,000 in investments, including a person holding a joint or community-property interest with a qualified purchaser spouse; a company owning at least $5,000,000 in investments that is owned by two or more natural persons related as siblings, spouses or former spouses, direct lineal descendants, their spouses, their estates, or foundations, charitable organizations or trusts established by or for them; a trust not covered by that family-company clause, not formed to acquire the securities offered, whose trustee and every settlor is itself a person described in one of the other clauses; and any person, acting for its own account or for the accounts of other qualified purchasers, that "in the aggregate owns and invests on a discretionary basis, not less than $25,000,000 in investments". A page that states the $5 million figure alone is describing the first clause, not the definition.

"Investments" is a defined term, and defining it as net worth is the common error. The SEC's rule, 17 CFR 270.2a51-1, lists what counts: securities (with an exclusion for securities of an issuer under common control with the purchaser, subject to carve-outs), real estate held for investment purposes, commodity interests and physical commodities held for investment purposes, certain financial contracts entered into for investment purposes, and cash and cash equivalents held for investment purposes, which the rule says include bank deposits, certificates of deposit, bankers acceptances and similar bank instruments, and the net cash surrender value of an insurance policy. The rule then narrows what "held for investment purposes" means. Real estate "shall not be considered to be held for investment purposes" if the person or a related person uses it "for personal purposes or as a place of business, or in connection with the conduct of the trade or business". So the family home and the building the family business operates from are both out.

Two mechanical rules finish the calculation. Investments are valued at fair market value on the most recent practicable date, or at cost. And there "shall be deducted from the amount of such person's Investments the amount of any outstanding indebtedness incurred to acquire or for the purpose of acquiring the Investments owned by such person". Margin borrowing used to build the portfolio therefore reduces the number the test is applied to. The practical result is that a person can be comfortably wealthy, comfortably an accredited investor, and still fall short of the qualified purchaser threshold, because the wealth is in a house, a business and leverage rather than in unencumbered investments.

There is a carve-out in subparagraph (C) that a summary should at least mention. A company that would itself be an investment company but for the exclusions in section 3(c)(1) or 3(c)(7), which the statute calls an "excepted investment company", is not a qualified purchaser unless all its pre-amendment beneficial owners, meaning those who acquired their securities on or before April 30, 1996, have consented to its treatment as one. The date is the tell that this is a grandfathering provision rather than a general rule, and it is why a fund investing in another fund cannot assume the status travels.

What the status buys, and who it is really for. Section 3(c)(7) takes an issuer outside the definition of an investment company where its outstanding securities "are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers", and where it is not making and does not propose to make a public offering. The companion exclusion, section 3(c)(1), does not impose a wealth test on investors but caps their number. So the qualified purchaser test is the price of an unlimited investor count, and it exists to serve the fund's structure rather than to certify anything about the person. How those funds actually operate is a separate subject.

The Regulation A sense, and why the statute permits the collision. Securities Act section 18(b)(3) makes a security covered "with respect to the offer or sale of the security to qualified purchasers", leaving the definition to an SEC rule, and then adds a sentence that resolves the whole confusion: in prescribing that rule the SEC "may define the term 'qualified purchaser' differently with respect to different categories of securities, consistent with the public interest and the protection of investors". Congress contemplated more than one definition. The SEC's rule for Regulation A takes the maximum advantage of that permission by defining the term as every purchaser in a Tier 2 offering, which is how Tier 2 securities became covered securities and dropped out of state registration. Read against the private-fund test, the two definitions point in opposite directions: one narrows the buyer pool to the wealthiest, the other widens preemption to everyone in a public offering that anyone may buy into.

Testing an individual against section 2(a)(51)(A)(i) runs in four steps:

1. Add up the investments, using the categories in the SEC's rule: securities, real estate held for investment, commodity interests and physical commodities held for investment, certain financial contracts, and cash and cash equivalents held for investment.

2. Take out what is not held for investment purposes, which removes the home the person lives in and any property used as a place of business.

3. Value what is left at fair market value on the most recent practicable date, or at cost.

4. Subtract borrowings incurred to acquire those investments, and compare the result with $5,000,000.

A hypothetical, to show why net worth is the wrong number. Assume Priya owns a home with $2,400,000 of equity, a building her business operates from worth $1,600,000, a securities portfolio worth $4,300,000, and $500,000 of cash held for investment, and that she borrowed $300,000 on margin to buy part of the portfolio. The home and the business premises are not held for investment purposes and drop out. Her investments are $4,300,000 plus $500,000, less the $300,000 borrowed to acquire them, which is $4,500,000. She is short of the $5,000,000 threshold and is not a qualified purchaser under that clause, even though her net worth is roughly $8,500,000 and she is comfortably an accredited investor. (Numbers hypothetical, for illustration.)

The gap between those two figures is the whole point of the definition. It is a test of unencumbered investable wealth, not of prosperity, and the two can differ by millions.

Pros

• The test measures investable assets rather than everything a person owns, which is a better proxy for the ability to absorb a total loss than a net worth figure inflated by a house.
• Excluding personal-use real estate and deducting acquisition borrowings makes the number harder to manufacture than a simple asset tally.
• Because the threshold is high, a fund relying on it can take an unlimited number of investors, which is what lets large institutional-style funds exist without registering under the Investment Company Act.
• The statute anticipated the two-definition problem and authorized it expressly, so the collision is a drafting choice rather than an accident to be worked around.

Cons

• Meeting the test is not a judgment that a person understands what they are buying. It is a wealth measure and nothing more, and the same criticism made of the accredited investor standard applies here with more force.
• The dollar figures are written into the statute and are not indexed to inflation, so their real value falls as prices rise.
• The status unlocks funds whose disclosure, valuation, liquidity and fee terms are set by contract rather than by the Investment Company Act, and the protections given up are substantial.
• Sharing a name with an unrelated Regulation A definition is a genuine hazard, and it appears in offering documents on both sides.