SEC Adopts Revisions to Net Worth Test for Accredited Investor Definition to Exclude the Value of a Person’s Primary Residence

On December 21, 2011, the SEC adopted final rules to exclude the value of a person’s primary residence for purposes of determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million. The amendments are similar to the proposal (discussed in this prior posting) in that net worth is calculated by excluding only the investor’s net equity in the primary residence (i.e. indebtedness secured by the primary residence is not treated as a liability, except to the extent it exceeds the estimated value of the primary residence).

The final rules include some notable changes from the proposal, however. One such revision is the addition of a grandfathering provision that permits individuals who qualified as accredited investors under the former net worth test to use that test for certain follow-on investments, provided that: (i) the right to purchase the securities 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.

Additionally, the final rule includes a provision that treats incremental debt secured by the residence incurred in the 60 days before the sale of securities as a liability in the net worth calculation, even if the estimated value of the primary residence exceeds the aggregate amount of debt secured by the primary residence. Accordingly, if any such incremental debt is incurred, net worth will be reduced by the amount of the incremental debt.  This approach is intended to prevent individuals from artificially inflating their net worth by borrowing against their primary residence to take advantage of any positive equity shortly before seeking to qualify as an accredited investor in an exempt securities offering.

The effective date of the amended rule is February 27, 2012. Beginning in 2014, and every four years thereafter, the SEC is required by the Dodd-Frank Act to review the definition of “accredited investor” and to make further amendments to the extent it deems appropriate. According to the press release announcing the amendments, the SEC has now proposed or adopted more than three-quarters of the rules required by the Dodd-Frank Act. For additional information, contact us at (619) 278-0020 to schedule a consultation.

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