On December 21, 2011, the Securities and Exchange Commission, in Securities Act Release No. 9287, amended net worth standard in the definition of “accredited investor” excluding the value of a person’s home from net worth calculations in order to participate in unregistered securities offerings as required by the Dodd-Frank Wall Street Reform Act and Consumer Protection Act (the “Dodd-Frank Act”). The amendments clarify the treatment of borrowing secured by a primary residence for purposes of the net worth calculation and under limited circumstances, permit persons who previously qualified as accredited investors pre-Dodd-Frank Act to use the prior net worth standard definition for certain follow-on investments.
The most significant revisions from the proposed rule include the addition of (i) a grandfathering provision that permits the application of the former accredited investor net worth test in certain limited circumstances and (ii) a provision addressing the treatment of incremental debt secured by the primary residence that is incurred in the 60 days before the purchase of securities.
The grandfather provision allows an investor to re-invest in a particular security under the pre-Dodd-Frank Act definition of net worth if the following requirements are satisfied: (i) the right to purchase was held by the person on July 20, 2010 (day before the effectiveness of the Dodd-Frank Act); (ii) person qualified as an accredited investor on the basis of net worth at the time of acquiring such right; and (iii) person actually held securities of the same issuer, other than such right, on July 20, 2010.
Under the amended net worth calculation, indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence, is not treated as a liability. Exceptions include indebtedness secured by a person’s primary residence in excess of the property’s estimated fair market value or borrowing that occurs in the 60 days preceding the purchase of securities in the exempt offering and is not in connection with the acquisition of the primary residence. In both cases, the excess debt or the recent debt acquired must be treated as a liability in the net worth calculation.
Of importance, the 60 day look-back provision was intended to prevent manipulation of the net worth standard by eliminating the ability of individuals to artificially inflate net worth by borrowing against home equity shortly before participating in an exempt securities offering. Further, the rules do not require a third party opinion on valuation of the primary residence or for any other assets or liabilities – only an estimate of fair market value.
Amended Net Worth Standard
The individual net worth standard in the accredited investor definition in Rule 501 and 215 of the Securities Act of 1933 is:
Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.
(1) Except as provided in paragraph (2) of this section, for purposes of calculating net worth under this paragraph:
(i) The person’s primary residence shall not be included as an asset;
(ii) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of the sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and
(iii) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability.
(2) Paragraph (1) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:
(i) such 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 person acquired such right; and
(iii) the person held securities of the same issuer, other than such right, on July 20, 2010.
Other Issues Considered
The SEC determined to not change the proposed rules to:
- Define “primary residence”
- Generally, exclude debt secured by a primary residence whether or not the proceeds were used to invest in securities (except for the 60 day look-back provision)
Effective Date: 60 days after publication in the Federal Register
If you have any questions on Securities Act Release No. 9287 or any other legal matter, please contact any of the partners at Evans & Kob, PC at firstname.lastname@example.org.
On Friday, August 12, 2011, the Securities and Exchange Commission’s much discussed whistleblower program became effective with the launch of a new webpage for people to report a violation of the federal securities laws and apply for a financial award and the introduction of the new Office of the Whistleblower.
To be considered for an award, the final rules require that a whistleblower must:
- Voluntarily provide the SEC …
- In general, a whistleblower is deemed to have provided information voluntarily if the whistleblower has provided information before the government, a self-regulatory organization or the Public Company Accounting Oversight Board asks for it directly from the whistleblower or the whistleblower’s representative.
- … with original information …
- Original information must be based upon the whistleblower’s independent knowledge or independent analysis, not already known to the SEC and not derived exclusively from certain public sources.
- … that leads to the successful enforcement by the SEC of a federal court or administrative action …
- A whistleblower’s information can be deemed to have led to a successful enforcement action if:
- The information is sufficiently specific, credible and timely to cause the Commission to open a new examination or investigation, reopen a closed investigation, or open a new line inquiry in an existing examination or investigation.
- The conduct was already under investigation when the information was submitted, and the information significantly contributed to the success of the action.
- The whistleblower reports original information through his or her employer’s internal whistleblower, legal, or compliance procedures before or at the same time it is passed along to the SEC; the employer provides the whistleblower’s information (and any subsequently-discovered information) to the SEC; and the employer’s report satisfies prongs (1) or (2) above.
- … in which the SEC obtains monetary sanctions totaling more than $1 million.
- The rules permit aggregation of multiple SEC cases that arise out of a common nucleus of operative facts as a single action. These may include proceedings involving the same or similar parties, factual allegations, alleged violations of the federal securities laws, or transactions or occurrences.
A successful blower may be entitled to 10-30% of the SEC sanctions over $1 million.
Contact Evans & Kob for experienced regulatory and legal counsel regarding whistleblower claims or any broker-dealer and investment adviser, arbitration, regulatory or securities matter at email@example.com.
On June 2, 2011, the Securities and Exchange Commission’s Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) have issued an investor alert called Structured Notes with Principal Protection: Note the Terms of Your Investment to educate investors about the risks of structured notes with principal protection, and to help them understand how these complex financial products work.
For investors considering such an investment, one should be mindful that structured notes with principal protection can have complicated pay-out structures that can make it hard to accurately assess their risk and potential for growth, the lack of liquidity on your principal and the possibility of no profit on their initial investment.
For more information, please review “Structured Notes with Principal Protection: Note the Terms of Your Investment” on the Securities and Exchange Commission’s website, which includes a list of suggested questions investors should ask before investing in these type of products.
On April 7, 2011, both FINRA and the SEC announced actions both broker-dealers and supervisory personnel in connection with sales of private placement offerings without adequate due diligence. The actions relate to private placement offerings of Medical Capital Holdings, Inc. (MedCap), Provident Royalties and DBSI – all entangled in various levels of litigation, SEC enforcement or arbitration.
In summary, the FINRA Acceptance, Waiver and Consent involve allegations that the firms, by or through its principals, failed to have reasonable grounds to identify and understand the inherent risks of the offering and the suitability of the offerings for any of their customers, including conducting effective due diligence to investigate potential “red flags,” and therefore could not have a reasonable basis to sell the offerings. The SEC alleges that the firm and its principal failed to perform reasonable due diligence on numerous private placements, while simultaneously receiving significant amounts in due diligence fees, that turned out to Ponzi schemes and offering fraud and thereby violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.
As to FINRA, we have already seen previous actions in regards to due diligence and our firm expects to see more investigations and audits of member firms in regards to both private placements and other non-traded direct investments, including REITs. See FINRA’s targeted examination request regarding “Sale and Promotion of Non-Traded REITs” and the 2011 Examination Priorities Letter. Contact Evans & Kob PC for experienced assistance responding to any regulatory examination or sweep, modifying your written supervisory procedures, due diligence review of a particular product, investment, issuer or money manager or any other regulatory or arbitration related legal advice at firstname.lastname@example.org.
On March 2, 2011, the Securities and Exchange Commission proposed rules to require certain financial institutions, broker-dealers and investment advisers with $1 billion or more in assets, to disclose their incentive-based compensation practices and prohibit such institutions from having compensation arrangements that encourage inappropriate risks.
1) Disclosures about Incentive-Based Compensation Arrangements
Annual Filing with appropriate federal regulator information including:
Narrative description of the components of the firm’s incentive-based compensation
Description of the firm’s policies and procedures governing such arrangements
A statement of why the firm believes the structure will help prevent it from suffering a material financial loss and/or why it does not provide covered persons with excessive compensation
2) Prohibition on Encouraging Inappropriate Risk
General prohibition against establishing or maintaining an incentive-based compensation arrangement that encourages inappropriate risks by providing excessive compensation, or that could lead to material financial loss – deemed assumption unless arrangements meet certain standards
“Covered persons” include executive officers, employees, directors, or principal shareholders
Prohibitions for larger financial institutions – specific requirements for executive officers and certain other designated individuals at financial institutions with $50 billion or more in total consolidated assets – 3 year deferral at least 50% of incentive-based compensation and must be adjusted for losses incurred
3) Establishing Policies and Procedures
A covered financial institution would be barred from establishing such arrangement unless the arrangement has been adopted under policies and procedures developed and maintained by the institution and approved by its board of directors.
Comments: should be received within 45 days after it is published in the Federal Register.
Assuming the rules are approved, financial institutions will need to significantly alter policies and procedures regarding incentive-compensation arrangements to ensure and monitor compliance with the requirements. Please contact our firm if you need experienced legal representation and advice if you need assistance updating your written supervisory procedures, providing comments to the SEC, or any other regulatory or arbitration related legal assistance at email@example.com.
As reported in Investment News on February 15, 2011, the SEC began a sweep of registered investment advisers and investment advisory firms to gather information about their use of social media such as Facebook, Twitter, LinkedIn, blogs and others. The sweep also focuses on gathering more information about policies and procedures that govern the use of social media, retention of records of employees’ use of social media, including non-business use and networking sites, and training provided to employees on the use of social media.
The SEC letter issued to advisers requests the following documents or information within an adviser’s possession or custody or subject to an adviser’s control:
- All documents sufficient to identify the adviser’s involvement with or usage of social media websites, including, without limitation:
- Twitter, including, without limitation, AdvisorTweets.com;
- Reddit; RSS; and
- Blogs and micro-blogs.
- All documents concerning any communications made by or received by the adviser on any social media website, including, without limitation, snapshots of documents responsive to Item 1, above.
- All documents concerning adviser’s policies and procedures related to the use of social media web sites, without limitation:
- All policies and procedures concerning any communication posted on any social media website;
- All policies and procedures concerning any prospective communications to be posted on any social media website; and
- All policies and procedures concerning any ongoing monitoring or review process related to communications posted on any social media website.
- All documents concerning policies and procedures concerning a third party’s use of any social media website maintained by adviser, including, without limitation:
- All policies and procedures concerning any communication posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser;
- All policies and procedures concerning any approval processes for prospective communications to be posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser; and
- All policies and procedures concerning any ongoing monitoring or review processes related to communications posted by a third party, including, without limitation, actual or prospective clients of adviser, on any social media website maintained by adviser;
- All documents concerning policies and procedures related to the use of social media websites by adviser’s personnel for personal, non-business related matters.
- All documents concerning personnel training and education related to the use of social media websites, whether for personal, non-business related, or business related matters.
- All documents concerning any informal or formal disciplinary action of personnel related to the use of social media for personal, non-business related, or business-related reasons.
- All documents concerning record retention policies and procedures concerning the involvement with or usage of, whether for personal, non-business related, or business-related matters, any social media website maintained by adviser by:
- The adviser;
- Adviser’s personnel; and
- Any third party.
At the same time, FINRA’s Social Networking Task Force is meeting next month to discuss updating its guidance on how advisers should use social-networking sites. The previous guidance was issued in Regulatory Notice 10-06.
Please contact our firm if you need assistance responding to any letter from the SEC or FINRA, modifying your policies and procedures, assessing your compliance risks, responding to any regulatory examination, or any other regulatory or arbitration related legal advice at firstname.lastname@example.org.