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.