SEC Adopts New Definition of Accredited Investor

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 Rule 215(e).

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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