Time to revise your form investment documents - as of February 27, 2012, the Securities and Exchange Commission's new accredited investor rule will take effect.  Affirming accredited investor status is crucial in determining whether an investment falls under the Regulation D safe harbors and qualifies for exemption from some of the more onerous and expensive disclosure obligations otherwise required by the Securities Act. 

Overview of the Changes

The change is substantially consistent with the proposed rules Jason Brady discussed in his blog from February 2011.   As dictated by Dodd-Frank, the calculation as to whether of person's net worth (or joint net worth with spouse) exceeds $1M must exclude the value of that person's primary residence, but indebtedness secured by that residence will not count as a liability (to the extent the debt does not exceed the fair market value of the residence).  In other words, positive equity will not count, but negative equity will. 

The SEC did address two new issues in the final rule as a result of comments received on the proposed rule:

  • Indebtedness secured by a primary residence in the 60 days preceding the purchase of securities will reduce net worth, irrespective of the residence's fair market value, unless such debt was incurred in connection with the acquisition of the residence.  This provision was added to reduce any temptations on the part of investors or salespersons to "game" the calculation rules by artificially inflating net worth.
  • Cognizant that some current investors would no longer qualify as accredited under the new rule, the SEC also added "grandfathering" provisions.  First, binding investment obligations made prior to Dodd-Frank will be judged using the old rules.  In addition, the old rules will apply to follow-on investments (i.e., exercise of pre-emptive rights) if the investor: (a) acquired a right to purchase prior to July 20, 2010; (b) qualified as an accredited investor at the time the right was acquired; and (c) held securities of the issuer (other than the right in (a)) at that same time. 

With respect to the above, note that the SEC declined to engage in the complexity of defining "primary residence" as that term has "a commonly understood meaning as the home where a person lives most of the time."          

Looking Forward

Dodd-Frank also required the SEC to undertake a review of the definition of "accredited investor" every 4 years from the enactment of Dodd-Frank.  However, the SEC has chosen to delay any action on this obligation until after the Comptroller General completes its related Dodd-Frank obligation - a report on "the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds."  According to the SEC, this study, due before the end of 2013, "will be taken into account in any rulemaking that takes place in this area."