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SEC Proposes Amendments to Accredited Investor Status

Insight February 16, 2011

The SEC recently voted to propose amendments to the net worth standard for determining accredited investor status under the Securities Act of 1933.  Under the proposal, the SEC's rules would be amended to exclude the value of an individual's primary residence in calculating net worth for the purposes of determining whether a person qualifies as an "accredited investor." 

 

             A proposed SEC amendment may reduce available private capital by qualifying fewer individuals as accredited investors.  On January 25, 2011, the Securities and Exchange Commission (the SEC) voted to propose amendments to the net worth standard for determining accredited investor status under the Securities Act of 1933 (the Securities Act.)  The proposed amendments reflect the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act.) 

 

            Section 413 was effective on July 21, 2010 upon enactment of the Dodd-Frank Act and requires that the net worth calculation for determining accredited investor status exclude the value of the person's primary residence.  The SEC is required to revise the Securities Act to reflect this new standard. 

 

            Under the proposal, the SEC's rules would be amended to exclude the value of an individual's primary residence in calculating net worth for the purposes of determining whether a person qualifies as an "accredited investor."  Previously, the net worth standard required a minimum net worth of more than $1 million but permitted the inclusion of the primary residence in the calculation.  The proposed amendments also clarify that the value of the primary residence is determined 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 proposed standard would amend the Securities Act by defining an accredited investor 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."

 

            There is no transition period for the new accredited investor net worth standard as it was effective upon enactment of the Dodd-Frank Act on July 21, 2010.  This new net worth standard will remain in effect until July 21, 2014, four years after the enactment of the Dodd-Frank Act.  Starting in 2014, the SEC will be required to review the definition of the term "accredited investor" ever four years and engage in further rulemaking to the extent it deems appropriate.    

 

            Under rules promulgated pursuant to the Securities Act, individuals and entities that qualify as "accredited investors" are eligible to participate in private and limited offerings which are exempt from Securities Act registration requirements.  One of the ways in which a person may qualify as an "accredited investor" is by having a net worth in excess of $1 million.  Therefore, by excluding the value of an investor's primary residence in calculating net worth, fewer individuals may qualify as accredited investors, thus reducing available private capital.

 

            Because Section 413(a) is already in effect, all companies should revise their standard forms of accredited investor questionnaire and investor representations and warranties to ensure that each investor's net worth is properly calculated. 

           

            The SEC is seeking public comments on the proposed rule through March 11, 2011.