On December 21, 2011, the SEC released its final rule amending the definition of an "accredited investor." The final rule memorializes revisions first effected in July 2010 by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which required that the value of an individual's primary residence be excluded when calculating net worth to determine accredited investor status. However, the final rule clarifies how to calculate an individual's net worth and provides a limited grandfathering provision. The final rule is effective as of February 27, 2012.
Calculating Net Worth
The Dodd-Frank Act specified that the value of an individual's primary residence – previously included in the net worth calculation – must be excluded in determining whether that individual's net worth exceeds $1 million. The SEC's final rule implements this change and clarifies how to calculate the net worth standard. Specifically, for purposes of calculating net worth:
- The individual's primary residence is not included as an asset;
- Indebtedness secured by the individual's primary residence (e.g. a mortgage) up to the estimated fair market value of such residence at the time of the sale of securities, is not included as a liability, except for certain indebtedness incurred in the 60 days prior to such sale (explained further, below); and
- Indebtedness secured by the individual's primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities must be included as a liability.
Increases in Mortgage Debt 60 Days Before Sale of Securities
The final rule seeks to prevent investors from artificially inflating their net worth by converting home equity into cash or other assets that can be included in the net worth calculation. In order to avoid circumvention of the net worth standard, the final rule requires that an increase in the amount of debt secured by a primary residence in the 60 days prior to the time of sale of securities must be included as a liability unless such indebtedness results from the acquisition of the primary residence. This provision applies even if the estimated fair market value of the primary residence exceeds the aggregate amount of debt secured by such primary residence.
As a general matter, investors need to satisfy the new net worth requirement when making subsequent investments. The final rule allows for the previous standard to be used for the purchase of securities made in accordance with an individual's pre-existing right to purchase such securities, provided that:
Such right was held by the individual on July 20, 2010;
The individual qualified as an accredited investor on the basis of net worth at the time such right was acquired; and
- The individual held the issuer's securities, other than such right, on July 20, 2010.