United States: SEC Amends Accredited Investor Net Worth Standards Per Dodd-Frank

The accredited investor standard has been revised to exclude the equity value of the investor's primary residence from the $1 million net worth threshold for individuals.¹ The Amendments will be effective 60 days after publication in the Federal Register.²

The Amendments provide that a person's primary residence may not be included as an asset in calculating that person's net worth. Likewise, debt secured by an investor's primary residence is not included as a liability in the net worth calculation.³ Nevertheless, indebtedness secured by a primary residence that exceeds the estimated fair market value of the primary residence (that is, when the primary residence is underwater) will be included as a liability in the net worth calculation.

The Amendments⁴ set the same standard under both Rule 501(a)(5) of Regulation D and Rule 215(e) under the Securities Act for individuals to qualify as accredited investors on the basis of net worth.⁵ Depending on an individual's personal situation, these Amendments may make it easier or more difficult to garner accredited investor status for a particular private placement.

To prevent investors from artificially inflating their net worth by increasing cash or other assets by securing additional debt on their primary residence, the SEC added a 60-day look-back provision. Under this provision, any increase in the amount of debt secured by a primary residence in the 60 days prior to the sale of securities will be included as a liability, even if the estimated fair market value of the primary residence exceeds the amount of debt secured by the primary residence.⁶

Recognizing that applying the new accreditation standards to investors who had a preexisting relationship with a specific issuer could present an unnecessary hardship, the SEC included a "grandfathering" provision in the new rules. If, as of July 10, 2010, an investor (i) had a right to purchase securities in the issuer, (ii) qualified as an accredited investor on the basis of net worth at the time the person acquired such right, and (iii) held securities of the same issuer, other than such a right, the new accreditation standards will not apply to the investor.

If you have any questions regarding the Regulations discussed above, please contact Laurence Lese, Richard Silfen, Robert Bramnik, David Kaufman, Joel Ephross, Michael Schwamm, Maria Granholm, Joseph Machi, any member of the Securities Law Practice Group, any member of the Broker-Dealer and Securities Regulation Practice Group or the lawyer with whom you are regularly in contact.

Footnotes

1. The amendments ("Amendments") were adopted on December 21, 2011, by the U.S. Securities and Exchange Commission (the "SEC") under the Securities Act of 1933 (the "Securities Act"). The Amendments reflect the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). Section 413(a) changed the net worth standard for accredited investors and required the SEC to revise the Securities Act rules to conform to the new standard. See SEC Release No. 33-9287, available at http://www.sec.gov/rules/final/2011/33-9287.pdf.

2. The change to the net worth standard became effective upon enactment of the Dodd-Frank Act. The Dodd-Frank Act requires the SEC to review the definition of "accredited investor" every four years, beginning four years after enactment of the Dodd-Frank Act.

3. The SEC states that net worth will be calculated only once, at the time of the sale of securities. As a result, consideration should be given as to the timing of the investor questionnaire, and, if there is a delay between the execution of the questionnaire and closing, whether the representations that are made in the questionnaire will still be valid at closing.

4. Under the new net worth standard, an accredited investor is "[a]ny person whose individual net worth, or joint net worth with that person's spouse, exceeds $1,000,000," calculated by:

5. The accredited investor standards, which are set forth in Rules 215 and 501 under the Securities Act, are used in determining the availability of certain exemptions from Securities Act registration for private and other limited offerings. Section 4(5) of the Securities Act exempts from registration transactions involving offers or sales by an issuer solely to one or more accredited investors, if the aggregate offering price does not exceed $5 million, there is no advertising or public solicitation in connection with the transaction, and the issuer files a notice with the SEC.

6. The SEC indicates, however, that it does not intend the 60-day look-back provision to address debt secured by a primary residence that is incurred in connection with the acquisition of a primary residence within the 60-day period.

This article is for general information and does not include full legal analysis of the matters presented. It should not be construed or relied upon as legal advice or legal opinion on any specific facts or circumstances. The description of the results of any specific case or transaction contained herein does not mean or suggest that similar results can or could be obtained in any other matter. Each legal matter should be considered to be unique and subject to varying results. The invitation to contact the authors or attorneys in our firm is not a solicitation to provide professional services and should not be construed as a statement as to any availability to perform legal services in any jurisdiction in which such attorney is not permitted to practice.

Duane Morris LLP, a full-service law firm with more than 700 attorneys in 24 offices in the United States and internationally, offers innovative solutions to the legal and business challenges presented by today's evolving global markets. Duane Morris LLP, a full-service law firm with more than 700 attorneys in 24 offices in the United States and internationally, offers innovative solutions to the legal and business challenges presented by today's evolving global markets. The Duane Morris Institute provides training workshops for HR professionals, in-house counsel, benefits administrators and senior managers.