Business Compliance Partners Summarizes the Finalized Net Worth Standard for Accredited Investors

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The Securities and Exchange Commission (“SEC”) finalized its new “net worth standard for accredited investors” rule, which will take effect on February 27, 2012, ending the regulatory limbo that existed after the enactment of the Dodd-Frank Act on July 21, 2010. The Act gave the SEC directives to implement regulations based on the guidelines and framework outlined in the Act. Two new provisions that impact individuals have made their way into the final rule. Business Compliance Partners analyzes these provisions.

The Securities and Exchange Commission (“SEC”) finalized its new “net worth standard for accredited investors” rule, which will take effect on February 27, 2012, ending the regulatory limbo that existed after the enactment of the Dodd-Frank Act on July 21, 2010.

The Act gave the SEC directives to implement regulations based on the guidelines and framework outlined in the Act. Two new provisions that impact individuals have made their way into the final rule. Business Compliance Partners analyzes these provisions.

Grandfathering Provision

The rule includes a grandfathering provision that permits the application of the former accredited investor net worth test when an investor qualified as an accredited investor on or prior to July 20, 2010, before the enactment of the Dodd-Frank Act.

The grandfathering provision allows such an accredited investor to exercise pre-existing rights to acquire securities if the accredited investor also held securities of the same issuer on or before July 20, 2010.

Mortgage Debt Increases before the Sale of Securities

A 60-day look-back provision was also introduced in the final rule. The purpose is to identify any increases in mortgage debt over the 60-day period preceding the purchase of securities. Net worth is reduced by the amount of the incremental debt incurred within the 60-day period. This is to prevent investors from borrowing against their primary residence in order to qualify as an accredited investor.

Since the value of an investor’s primary residence will now be excluded from the net worth calculation, investors may be tempted to convert their home equity into cash or another allowable asset.

The SEC wants to prevent unregistered securities from being sold to investors with limited assets other than their homes. The SEC is also seeking to discourage financial advisors from recommending that their clients use their home equity to help them qualify as accredited investors.

Background

The two new provisions were added in response to several comments that the SEC received. Before a rule becomes final the SEC releases a proposed rule and allows interested parties to review it and voice concerns or make comments. Based on feedback received, the SEC may choose to make amendments to the proposed rule. The SEC may also choose to extend the comment period if important issues have been raised in previous comments.

Other Changes

A natural person is considered an accredited investors if individually, or jointly with their spouse, they have a net worth of more than $1,000,000 excluding the value of their primary residence. Any debt that is secured by the person’s primary residence in excess of its estimated fair market value at the time of the sale of securities will be included as a liability in the net worth calculation.

The SEC is authorized to review the term “accredited investor” as it applies to natural persons, and in its entirety every four years beginning four years after the enactment of the Dodd-Frank Act and may make adjustments.

The Comptroller General of the United States is also tasked with examining the criteria needed to qualify for accredited investor status and eligibility to invest in private funds.

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Paul Cox

Chris Kosifas
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