New SEC Compliance Guide Regarding Accredited Investor Standards

By Cydney Posner

The SEC has issued a new Compliance Guide regarding the accredited investor standards that were recently revised as a result of Dodd-Frank. Dodd-Frank required that the value of a person's primary residence be excluded when determining whether the person qualifies as an "accredited investor" on the basis of having a net worth in excess of $1 million. (At the same time, the SEC has withdrawn Securities Act Rules CDIs 179 and 255, which related to the prior version of that definition.)

The Compliance Guide makes clear that the primary residence, which is not defined but commonly understood to mean the home where a person lives most of the time, is not counted as an asset in the net worth calculation. In general, debt secured by the primary residence (such as a mortgage or home equity line of credit) is not counted as a liability if the estimated fair market value of the residence is greater than the amount of debt secured by it. (Note that there is no requirement to obtain a third-party estimate of the fair market value of the residence.) However, if the amount of debt on the home has increased in the 60 days preceding the sale of securities to the investor (other than in connection with the acquisition of the primary residence), then the amount of that increase is included as a liability, even if the estimated value of the residence is greater than the amount of debt secured by it. (The purpose of this provision is to deter individuals from incurring debt secured by their primary residence for the purpose of inflating their net worth to qualify as accredited investors.)

If the amount of the secured debt exceeds the estimated fair market value of the residence (e.g., when the house is underwater), then the excess is included as a liability in the net worth calculation, even if the borrower may not be personally liable for the excess amount.

The former accredited investor net worth test, under which the primary residence and indebtedness secured by it were included in the net worth calculation, applies to certain follow-on investments in accordance with a right to purchase, if:

• The right was held by a person on July 20, 2010, the day before the enactment of Dodd-Frank;
• The person qualified as an accredited investor on the basis of net worth at the time the right was acquired; and
• The person held securities of the same issuer, other than the right, on July 20, 2010.

For those in need, the Compliance Guide includes some sample calculations.

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