SEC Adopts Amendments to Its Accredited-Investor Net-Worth Standard
The Securities and Exchange Commission announced on Dec. 21, 2011 that it has adopted amendments to its rules regarding the net-worth standard (PDF) for determining an individual “accredited investor” for purposes of certain exemptions from the registration requirements of the Securities Act of 1933, as amended. As described in our post when the amendments were proposed by the SEC in January 2011, the amendments are required to conform the net-worth standard to one of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The amendments as adopted are substantially similar to those proposed, with two principal exceptions. As was proposed, the amended rules specify that, for purposes of the $1 million net-worth standard:
- an individual’s primary residence will not be deemed an asset; and
- indebtedness secured by the primary residence will not be deemed a liability except to the extent it exceeds the estimated fair market value of the primary residence.
The amendments as adopted include two provisions not included in the proposed amendment:
- An individual must include as a liability any indebtedness secured by his or her primary residence within 60 days preceding his or her purchase of securities in the exempt offering, unless that indebtedness was incurred in connection with the acquisition of the primary residence. Accordingly, if an individual borrowed an amount as a home-equity loan within 60 days before purchasing in an offering, that borrowed amount would be a liability even if it is less than the estimated fair market value of the primary residence. The SEC explained that this provision is intended to preclude a prospective investor from “gaming” the net-worth standard by increasing his or her assets (and, therefore, net worth) through borrowing against the equity in his or her primary residence (which otherwise would not be counted as an asset).
- The net-worth standard for determining an individual accredited investor that was effective before the effectiveness of the Dodd-Frank Act on July 21, 2010 will apply, in lieu of the standard as amended, in the case of any individual who exercises a right to purchase securities of an issuer – such as a statutory or contractual pre-emptive right, a right to acquire securities upon exercise of an option or a warrant or upon conversion of a convertible instrument, or a contractual right of first offer or first refusal – where (1) the right was held on July 20, 2010, (2) the individual was an accredited investor on the basis of net worth at the time he or she acquired the right, and (3) the individual held securities of the same issuer, other than that right, on July 20, 2010. The SEC explained that this limited “grandfathering” provision is intended to preserve from impairment rights that investors bargained for under the previously effective standard.
The adopted amendments will be effective 60 days after they are published in the Federal Register.
OUR TAKE: Issuers conducting an exempt private offering to accredited investors under Regulation D or Section 4(5) of the Securities Act should revise their purchaser questionnaires or subscription documents to elicit all of the information necessary to determine compliance with the net-worth standard as now amended. The revisions should include information about any indebtedness secured by an individual’s primary residence incurred within 60 days before his or her purchase in the offering.