3 January 2012
The Securities and Exchange Commission has amended its net worth standard for accredited investors. This definition is an integral part of the rules that permit certain private and limited offerings to be made without registration—and without requiring specified disclosures—when sales are made only to accredited investors.
The Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the definition of accredited investor in rules issued under the Securities Act of 1933 be revised to exclude the value of a 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 on July 21, 2010, that statute required the SEC to amend the Securities Act rules to reflect the new standard. Accordingly, on December 21, 2011, the SEC amended its rules to implement this Dodd-Frank Act provision. The amended net worth rules become effective on February 27, 2012.
The SEC amended 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 SEC also adopted technical amendments to Form D and a number of other rules to conform them to the corresponding Dodd-Frank Act requirements.
The amendments specify that for the purpose of calculating net worth, a person’s primary residence shall not be included as an asset. Accordingly, under the amended rules, net worth is calculated excluding any positive equity that an individual may have in his or her primary residence.
Mortgage debt secured by a person’s primary residence is not treated as a liability for this net worth calculation, except to the extent that it exceeds the estimated fair value of the primary residence (i.e., an underwater mortgage). In addition, any increase in the amount of mortgage debt secured by the primary residence (e.g., to secure a home equity loan) in the 60-day period prior to the sale of securities will be treated as a liability for net worth calculation purposes, unless it was incurred in connection with the acquisition of the primary residence. This 60-day provision, which was not included in the original proposal, was added to prevent investors from artificially inflating their net worth by incurring additional indebtedness secured by their primary residence, effectively converting home equity—which would now be excluded from net worth—into assets which would be included in net worth.
The amended 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.
The amendments provide a limited grandfathering provision in connection with an investor’s exercise of certain preexisting rights to acquire securities so long as (i) the right was held by the person on July 20, 2010, (ii) the person qualified as an accredited investor on the basis of net worth at the time the right was acquired and (iii) the person held securities of the same issuer, other than such right to acquire securities, on July 20, 2010. These preexisting contractual rights may include rights of first offer or first refusal, contractual preemptive rights, and rights arising under state law or under the constituent documents of an entity.
A capital call regarding a commitment that was made prior to enactment of the Dodd-Frank Act generally is not subject to using the amended definition (e.g., for a private equity fund or a closed-end real estate fund). However, new purchases in other private funds, such as hedge funds, will be subject to the amended definition unless the limited grandfathering provision applies. Funds that make use of a dividend or distribution reinvestment plan should also consider whether the use of such a plan results in the issuance of a new security under relevant SEC guidance.
Under the Dodd-Frank Act, the SEC is required to review the “accredited investor” definition in its entirety every four years after enactment of the Dodd-Frank Act, and to engage in further rulemaking to the extent it deems appropriate. On this timetable, the first SEC review will begin after July 21, 2014.
If you have any questions about the amendment to the accredited investor definition, please contact the author of this Legal Update, Laura D. Richman, at +1 312 701 7304, or your regular Mayer Brown lawyer.
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