On December 21, 2011, the Securities and Exchange Commission ("SEC") amended its rules to implement Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").1 Section 413(a) requires that the value of a person's primary residence be excluded from the net worth calculation used to determine the person's "accredited investor" status. The final rule is the same as the proposed rule as to the exclusion of the primary residence under the net worth test and the treatment of indebtedness secured by the primary residence.2 The adopted rule differs from the proposed rule with the addition of: (1) a grandfathering provision that permits the application of the former accredited investor standard in certain limited circumstances and (2) a provision addressing the treatment of incremental debt secured by the primary residence that is incurred in the 60 days before the sale of the securities in the private offering.

Background

Accredited investor standards are set forth in rules 215 and 501 under the Securities Act of 1933 (the "Securities Act") and are used in determining the availability of certain exemptions from registration for private and other limited offerings.3 Formerly, an individual investor and his or her spouse were permitted to include the net equity value of their primary residence in calculating whether they qualified for accredited investor status. Section 413(a) of the Dodd-Frank Act requires the SEC to adjust the net worth standard for natural persons individually or jointly with their spouse, to "more than $1,000,000...excluding the value of the primary residence." Section 413(a) became effective immediately upon enactment of the Dodd-Frank Act on July 21, 2010, but the SEC was required to amend its rules to conform to the new standard.

New Standard

In amending rules 215 and 501, the SEC adopted identical language in defining individual accredited investor status to require net worth in excess of $1,000,000, provided that "[t]he person's primary residence shall not be included as an asset." The amended rules also provide that, in calculating net worth, an individual's mortgage indebtedness on a primary residence shall be treated as follows:

  • Indebtedness secured by the person's primary residence, up to the estimated fair market value of the residence, is not treated as a liability, unless the borrowing occurs in the 60 days preceding the purchase of securities in the exempt offering and is not in connection with the purchase of the primary residence. In such instance, the indebtedness must be treated as a liability.
  • Any indebtedness secured by a person's primary residence in excess of the property's estimated fair market value is treated as a liability.

Grandfathering

The provisions of the amended rules excluding the value of a primary residence is not applicable to any calculations of net worth made in connection with the purchase of securities in accordance with a right to purchase such securities in an exempt offering, provided that:

  • such right was held by the person on July 20, 2010;
  • the person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and
  • the person held securities of the same issuer, other than such right, on July 20, 2010.

Effective Date

The amended rules will take effect 60 days after publication in the Federal Register.

Mandated Study

Section 415 of the Dodd-Frank Act requires the Comptroller General of the U.S. 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 the enactment of the Dodd-Frank Act and will be taken into account by the SEC in future rulemakings in this area.

Conclusion

The exclusion of an individual's primary residence from the net worth calculation may result in a number of investors who had previously qualified for accredited investor status no longer being able to do so. Further, given the decline in property values where a significant number of homes are underwater, the updated definition may have an additional indirect impact in that it requires individuals to take into account the negative equity value in their primary homes but does not permit the inclusion of positive equity value in the calculation.

Footnotes

1 See Securities and Exchange Commission, Net Worth Standard for Accredited Investors, Release No. 33-9287 http://www.sec.gov/rules/final/2011/33-9287.pdf

2 See Fried, Frank, Harris, Shriver & Jacobson Client Alert, SEC Releases Proposed Rule on Net Worth Standard for Accredited Investors to Implement Dodd-Frank Act, February 3, 2011, http://www.friedfrank.com/index.cfm?pageID=25&itemID=6324 ; Fried, Frank, Harris, Shriver & Jacobson Client Alert, Dodd-Frank Act Excludes Primary Residence From Accredited Investor Net Worth Standard, July 23, 2010, http://www.friedfrank.com/index.cfm?pageID=25&itemID=6229

3 Rule 215 applies to issuers relying on Section 4(5) of the Securities Act, while Rule 501 applies to issuers relying on Rule 504, 505 or 506 under Regulation D.

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