The SEC has proposed rules pursuant to Section 413(a) of the Dodd-Frank Act which requires the definition of “accredited investor” in the SEC’s Securities Act rules to exclude the value of a person’s primary residence for purposes of determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million. The amended definition of the term “accredited investor” appears to contain few surprises and is as follows:
“Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, 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.”
The SEC considered proposing amendments that would have defined the term “primary residence” for purposes of the amended rules. While the SEC is soliciting comment on whether a definition should be added to the rule, the proposal does not contain a definition, consistent with the SEC’s past policies in this area, and in an attempt to avoid unnecessary complexity.
The SEC believes issuers and investors should be able to use the commonly understood meaning of “primary residence”—the home where a person lives most of the time. The SEC also believes if additional analysis is needed under complex or unusual circumstances, helpful guidance may be found in rules that apply in other contexts, such as income tax rules and rules that apply when acquiring a mortgage loan for a primary residence, which often bears a lower interest rate than other mortgage loans.
The SEC is not proposing any special rules for transition to the new accredited investor net worth standards, since these new standards were effective upon enactment of the Dodd-Frank Act. Under the current rules, a company or fund is not permitted to treat an investor as accredited if the investor subsequently loses that status, even if the investor has previously invested in the company or fund at a time when it satisfied the accredited investor standard. Investors must satisfy the applicable accredited investor income or net worth standard in effect at the time of every exempt sale of securities to the investor that is made in reliance upon the investor’s status as such. The proposed amendments would not change this situation.
The SEC nevertheless is seeking comment on whether some transition and other rules might be appropriate to facilitate subsequent investments by an investor who previously qualified as accredited but was disqualified by the change effected by the Dodd-Frank Act. For example, an investor that qualified as an accredited investor in a previous sale under Regulation D before enactment of the Dodd-Frank Act may wish to invest in the same company or fund in order to retain its proportionate interest in the company or fund or to exercise rights that have arisen because of that interest. Or a company may wish to make a rights offering to current investors who invested as accredited investors. In this case, the company may not wish to be subject to the additional information requirements it may incur under Regulation D if it offers and sells securities to non-accredited investors, and the company may be precluded from making the offering if the number of non-accredited investors exceeds the limit of 35 non-accredited investors imposed in Rule 505 and Rule 506 offerings. In some of these cases, the investor may have spent a substantial amount of time and money performing due diligence on the company or fund before his or her previous investments and may be familiar with the issuer as an existing investor. Under these circumstances, some have argued that the investor should be able to invest again as an accredited investor even if the investor does not satisfy the standards applicable at the time of the subsequent investment.
In addition, Section 413(b) of the Dodd-Frank Act specifically authorizes the SEC to undertake a review of the definition of the term “accredited investor” as it applies to natural persons, and requires the SEC to undertake a review of the definition “in its entirety” every four years, beginning four years after enactment of the Dodd-Frank Act. The SEC is also authorized to engage in rulemaking to make adjustments to the definition after each such review. The SEC is not proposing to make revisions to the definitions of “accredited investor” that are not required by the Dodd-Frank Act at this time, but may consider doing so in future rulemaking. Section 415 of the Dodd-Frank Act requires the Comptroller General of the United States to conduct a “Study and Report on Accredited Investors” examining “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.” The study is due three years after enactment of the Dodd-Frank Act. The SEC expects that the results of this study will inform any future rulemaking in this area that takes place after the study is completed.
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