$1,000,000 … excluding the value of the primary residence.”8
Before the adoption of section 413(a), the
standard under Rules 215 and 501(a)(5) required a minimum net worth of more than $1 million, but permitted an individual investor and his or her spouse to include the net equity value of their primary residence in calculating whether they qualified for accredited investor status.9 In amending Rules 215 and 501(a)(5) to conform to the
new standard under the Dodd-Frank Act, the SEC adopted identical language in the two rules,10
defining
individual accredited investor status to require net worth in excess of $1 million, provided that “[t]he person’s primary residence shall not be included as an asset.” The final accredited investor definition is consistent with the approach taken in the proposing release with respect to the basic treatment of the primary residence and indebtedness secured by the primary residence.11
The final rules also
provide a specific provision addressing the treatment of incremental debt secured by the primary residence that is incurred in the 60 days before the sale of securities to the individual in the exempt offering and certain new grandfather provisions. The new standard discusses the treatment of mortgage
debt in calculating net worth. “Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability …”12
Thus, under the final rules, as in the
proposing release, net worth is calculated by excluding positive equity an investor may have in its primary residence.13
The SEC believed this approach to be the most
appropriate way to conform its rules to section 413(a) stating: “it reduces the net worth measure by the net amount that the primary residence contributed to net worth before enactment of section 413(a), which we believe is what is commonly meant by ‘the value of a person’s primary residence’.”14
The final rules also provide
that any excess of indebtedness secured by the primary residence over the estimated fair market value of the residence is considered a liability for purposes of determining accredited investor status on the basis of net worth, whether or not the lender can seek repayment from other assets in default.15
In the SEC’s view, the full amount
of the debt incurred by the investor is the most appropriate value to use in determining accredited investor status.16
Continuing review and mandatory study Section 413(b) of the Dodd-Frank Act provides that four years after enactment, and every four years thereafter, the SEC must review the accredited investor definition as
applied to natural persons, including adjusting the threshold, although it may not be lowered below $1 million.17
Section 415 of the Dodd-Frank Act requires the
Comptroller General of the United States to conduct a Study and Report on Accredited Investors examining “the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.”18 The study is due three years after the enactment of the Dodd-Frank Act and is expected to be taken into account by the SEC in future rulemakings in this area.19
Proposed revisions of the accredited investor standard These recent changes to the accredited investor standard did not fundamentally alter the basic premise of the definition – that is, net worth continues to be used as a proxy for financial sophistication, or, at least for the ability to bear a certain measure of investment risk. The commentators writing to the SEC in connection with the Rule 506 rulemaking have noted that perhaps the net worth test has outlived its usefulness and that other standards should be considered that might better identify a category of investors not needing the protections afforded in connection with registered securities offerings. For example, the Investment Company Institute in its comment letter stated: We firmly believe that the income and net worth tests
in the definition of accredited investor no longer serves their intended purpose: to identify a universe of individual investors that can fend for themselves and do not need the protections of the securities laws. There is no question that the income and net worth tests have substantially eroded since 1982, when they were established. Others have cited greater concerns in connection with offerings using general solicitation conducted by private funds or hedge funds, and have suggested that the SEC consider a separate sophistication standard for offerings by private funds. Yet another group of commentators has observed that the level of financial literacy remains remarkably low. In fact, the SEC published a study on financial literacy, mandated by section 917 of the Dodd- Frank Act, which found that retail investors in the United States lack basic financial literacy.20
Large accredited investors In August 2007, the SEC proposed a variety of changes relating to private placements, some of which were adopted. In those proposals, the SEC had considered creating a new a new exemption (Rule 507) from the
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