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What Exactly Is an “Accredited Investor”? New SEC Final Rule Amends Definition

December 22, 2011

Yesterday, the SEC adopted amendments to the accredited investor standards under the Securities Act of 1933, as required by Section 413(a) of the Dodd-Frank Act. Section 413(a) requires the definition of “accredited investor” in the Securities Act’s rules to exclude the value of a person’s primary residence when determining whether the person has a net worth in excess of $1 million and is therefore eligible to invest in Regulation D exempt securities offerings.

Photo by Bryan Gosline. Some rights reserved.

As amended, the accredited investor rule will exclude any positive net equity an investor may have in his or her primary residence. Similarly, indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence, will not be treated as a liability, unless the borrowing 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 such cases, the debt secured by the primary residence must be treated as a liability in the net worth calculation. In addition, any indebtedness secured by a person’s primary residence in excess of the property’s estimated fair market value is treated as a liability under the new definition.

The final rule amendments also include a grandfathering provision that permits the application of the former accredited investor net worth test in certain limited circumstances. The former accredited investor net worth test will apply so long as: (i) the person held the right to purchase the exempt securities on July 20, 2010, the day before the enactment of the Dodd-Frank Act; (ii) the person qualified as an accredited investor on the basis of net worth at the time the right was acquired; and (iii) the person held securities of the same issuer, other than the right, on July 20, 2010.

The amended net worth standard will take effect 60 days after publication in the Federal Register, which is expected during the week of December 26. Beginning in 2014, and every four years thereafter, the Dodd-Frank Act requires the Commission to review the “accredited investor” definition in its entirety and to engage in further rulemaking to the extent it deems appropriate.

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