SEC’s new standard for “accredited investors” took effect February 27, 2012

The U.S. Securities and Exchanges Commission’s new standard to determine whether a party qualifies as an “accredited investor” went into effect Monday, February 27, 2012

Accredited Investors.  There are several ways in which people may qualify as an accredited investor under Regulation D of the Securities Act of 1933. One method by which an individual person may gain accredited status is by having a net worth of at least $1 million, either alone or combined with his or her spouse.

Change in Net Worth Definition.  It is this method that has been changed as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the new standard, when determining whether a person qualifies as an accredited investor, individuals will be unable to include their primary residence as an asset in calculating net worth. Moreover, debt secured using the individual’s primary residence, up to its fair market value, is treated as a liability for the pending securities purchase if the borrowing occurs within the 60 days leading up to the securities purchase.

Purpose.  According to the SEC, this change is “intended to prevent manipulation of the net worth standard” by removing the ability of people to “artificially inflate net worth” under the new standard by borrowing against their primary residence in the weeks leading up to the transaction.

Grandfathering.  Some accredited investors will not have to qualify under the new test so long as certain criteria are met under the amendments’ “grandfather” provisions. The new standard “will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities,” (such as options or warrants) so long as: “(i) [s]uch right was held by the person on July 20, 2010; (ii) [t]he person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and (iii) [t]he person held securities of the same issuer, other than such right, on July 20, 2010.”

Required Actions.  Issuers of securities should amend their offering and subscription documents to reflect the change in the accredited investor definition.  Investors should discuss the implications of the amendment with their accountants or financial advisers to determine if they qualify as accredited investors in connection with a proposed purchase of securities.