On December 21, 2011, the Securities and Exchange
Commission adopted final rules for calculating net worth under the new
definition of Accredited Investor. As adopted in July 2010, Section 413(a) of the Dodd-Frank Act requires the
definition of "accredited investor" in the Securities Act 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. On December 21, 2011, the SEC adopted conforming
amendments to Securities Act Rule 501(a)(5) of Regulation D and Securities Act
As clarified by the SEC, investor now has to exclude the positive equity of his
or her primary residence from the calculation of net worth to determine if he
or she is an accredited investor. For example, if the fair market value of the
primary residence is $500,000 and the mortgage on that residence is $300,000, then
the positive equity is $200,000. This is the amount the investor excludes from
the calculation of net worth. However, if the mortgage exceeded the fair market
value (for example, the mortgage is $600,000 rather than $300,000 in the
previous example), then that difference of $100,000 is reflected as a liability
in the balance sheet of the investor.
There is another twist. According to the final rules, if the investor takes out
more mortgage (debt secured by the primary residence) in the 60 days before the
accredited investor determination is made (other than debt incurred in
connection with the acquisition of a primary residence), then all such debt
will be treated as a liability in the net worth calculation and will not be
netted against the value of the residence. This provision eliminates investors'
ability to artificially inflate their net worth for purposes of the accredited
investor definition by taking on extra debt secured against their residence
shortly before participating in an exempt offering.
Investor questionnaires may need to get adjusted to reflect these new tests.
Investors will likely need to get a valuation of their residences to determine
their fair market value. They will also need to disclose value of the mortgages
and the timing of when such mortgages incurred.
Read more commentary from Arina Shulga on the
legal aspects of operating new and growing businesses at Business Law Post.
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