The Securities and Exchange Commission ("SEC") has proposed amendments1 to its rules to conform the definition of "accredited investor" to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").2 Section 413(a) of the Dodd-Frank Act requires the definitions of "accredited investor" in the SEC's 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 $1.0 million. This change to the net worth standard was effective upon enactment by operation of the Dodd-Frank Act, but Section 413(a) also requires the SEC to revise its rules under the Securities Act of 1933 (the "Securities Act") to reflect the new standard. The SEC is also proposing technical amendments to Form D and other rules to conform them to the language of Section 413(a) and to correct cross-references to Section 4(6) of the Securities Act, which was renumbered Section 4(5) by Section 944 of the Dodd-Frank Act.
The change to the accredited investor definition is of significant importance for securities issuers as various exemptions for private or other limited offerings of securities under the Securities Act and state "blue sky" laws depend on whether participants are "accredited investors." One of the bases on which individuals may qualify as accredited is having a net worth of at least $1.0 million, either alone or together with their spouse. Non-accredited investors who participate in private offerings under Rule 505 or Rule 506 of Regulation D must receive financial and other information that is not required to be given to accredited investors, and in offerings relying on Rule 506 there is a limit of 35 non-accredited investors.
Under the SEC's proposal, the net worth standards for an "accredited investor" under Rule 501 of Regulation D and Rule 215 would read 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.
As a result, under the proposed rule, an investor's net worth would be reduced by the amount of "value" that the primary residence would have contributed to net worth if the residence were not required to be excluded.
The SEC also is soliciting comments on any matters that may affect the proposal, as well as the following specific questions:
- Should the value of the residence be calculated by netting out the debt secured by the residence, as proposed, or would it be more appropriate to exclude the entire fair market value of the residence from net worth, without netting out any associated debt?
- Would it be more appropriate to use the word "equity" instead of the word "value" when referring to the primary residence in the net worth standard?
- Should the term "primary residence" be defined and, if so, should the federal income tax code definition be used?
- Should securities purchased with the proceeds of debt, secured by a primary residence, be excluded from the calculation of net worth?
- Should the calculation of net worth be made on a specified date, such as 30, 60, or 90 days before the sale of securities under Regulation D, to prevent investors from inflating their net worth by borrowing against their homes?
- Should a rule be adopted to enable an investor, who previously qualified as accredited but was disqualified by the change effected by the Dodd-Frank Act, to make subsequent or "add-on" investments?
The deadline for submitting comments on the proposed rules is March 11, 2011.
The new net worth standard must remain in effect until July 21, 2014, four years after enactment of the Dodd-Frank Act. Beginning in 2014, the SEC is required to review the "accredited investor" definition every four years and engage in further rulemaking to the extent it deems appropriate.
What to Do?
Because Regulation D requires that "accredited investor" status is determined and documented at the time of investment, investors relying on the $1.0 million net worth test must confirm that their net worth is calculated without including the value of their primary residence. If they have not already done so, issuers also must revise their standard forms of subscription documents to reflect the new net worth requirement. Further revisions to subscription documents may be necessary when the SEC adopts a final rule.