The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) required that the definition of “accredited investor” in rules issued under the Securities Act of 1933 (Securities Act) exclude the value of a natural person’s primary residence for purposes of determining whether a natural person has a net worth in excess of $1 million. While the change to this net worth standard became effective upon the enactment of the Dodd-Frank Act, that statute required the Securities and Exchange Commission (SEC) to amend the Securities Act rules to reflect the new standard. Accordingly, on January 25, 2011, the SEC proposed rules to implement this Dodd-Frank Act provision.1
The SEC has proposed amendments to the portion of the accredited investor definition that qualifies a natural person investor as accredited based on net worth under both Rule 501 of Regulation D and Rule 215. The amendments add the phrase “excluding the value of the primary residence of such natural person” after the requirement that the investor’s net worth “exceeds $1,000,000.”
In addition, the proposed rules clarify that net worth is determined by excluding only the investor’s net equity in the primary residence. As proposed, the value of the primary residence that is excluded from net worth for the purposes of determining accredited investor status is “calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.” As a result, indebtedness secured by the primary residence would be netted against the value of the primary residence only up to its fair market value—in other words, indebtedness secured by the primary residence in excess of the fair market value of the primary residence will be deducted from the investor’s net worth.2
The proposed rules do not define the term “primary residence.” The adopting release references the commonly understood meaning of a home where a person lives most of the time and points out that, in complex or unusual circumstances, guidance may be found in other contexts, such as income tax rules and rules that apply when acquiring mortgage loans.
Because the applicable Dodd-Frank Act provision is already effective, the SEC did not propose a transition period for its proposed rule change.
Comments on these proposed rules are due March 11, 2011. The SEC specifically requested comments on whether the rules should specify a date in advance of the sale of securities for the calculation of net worth, whether the rules should require inclusion of debt secured by a primary residence in the net worth standard if the proceeds of the debt are used to invest in securities and whether the term “primary residence” should be defined.
One major issue that the proposal did not address was whether the accredited investor status for existing natural person investors would be “grandfathered” if they no longer qualify as an accredited investor after the rule and statutory change. Two commissioners raised specific concerns that the lack of a grandfathering provision may cause existing accredited investors to be diluted if they are not permitted to make additional investments in companies that they had previously invested in, or that their contractual rights might otherwise become void.