Regulation D Accredited Investor Definition Change

Corporate Attorney Jeffrey SomersBy: Jeffrey Somers

Dodd-Frank recently amended the $1 million net worth accredited investor test for individuals under Regulation D (Reg D) to exclude the value of the investor’s primary residence. Dodd-Frank required the U.S. Securities and Exchange Commission (SEC) to adopt rule amendments to effect this change, which the SEC did on December 21, 2011. The rule amendments are effective February 27, 2012. You can find the final rule here.

Under the amended definition the value of an investor’s primary residence may not be included in calculating the investor’s net worth for purposes of Reg D. Likewise, debt (any mortgages and home equity loans) secured by an investor’s primary residence is ignored unless the debt exceeds the estimated fair value of the residence (an underwater mortgage), in which case excess of the mortgage debt over the fair value is included as a liability in calculating net worth. In addition, any increase in the amount of an investor’s mortgage debt within 60 days prior to the investor making the investment in question must be treated as a liability for purposes of calculating net worth (the theory being that the investor has taken value out of the residence, which is supposed to excluded, to raise cash to make the investment). This latter provision is not part of Dodd-Frank.

The amended rule does not define “primary residence” but the SEC adopting release refers to the common understanding that it is the home where the investor lives most of the time.

There is limited grandfathering for an investor’s exercise of rights to acquire securities provided (i) the right was held by the investor on July 20, 2010 (the enactment date of Dodd-Frank), (ii) the investor was an accredited investor at the time the rights were acquired, and (iii) the investor held securities of the same issuer, other than the rights, on July 21, 2010.

A capital call on a commitment made prior to July 21, 2010, is generally not subject to the amended definition. However, the definition would apply in the case of new purchases in a private fund unless the grandfathering provision applies.

Unless they have been already in response to Dodd-Frank, all subscription agreements that we use should be appropriately modified to reflect the new definition.

For more information, please contact Jeffrey Somers.

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