Dodd-Frank Act Amends the Definition of Accredited Investor

On July 21, 2010 President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law.  The Dodd-Frank Act focuses primarily on financial institutions; however, there are several provisions that affect non-financial institutions, like Section 413(a)’s adjustment to the definition of “accredited investor”.

Prior to enactment of the Dodd-Frank Act a person was considered an accredited investor under both Rules 215 and 501(a)(5) of the Securities Act if:

• in each of the two most recent years they had income in excess of $200,000, or in excess of $300,000 jointly with a spouse, and had a reasonable expectation of reaching that same income level in the current year; or

• they had a net worth, individually or jointly with a spouse, in excess of $1,000,000.

Section 413(a) adjusts this second standard by requiring that any calculation of net worth exclude the value of a person’s primary residence.  This adjustment is effective immediately.

The Securities and Exchange Commission, in responding to inquiries on how to determine the value of a primary residence, has updated its Compliance and Disclosure Interpretations (here and here) with the following guidance:

Section 413(a) of the Dodd-Frank Act does not define the term “value,” nor does it address the treatment of mortgage and other indebtedness secured by the residence for purposes of the net worth calculation. As required by Section 413(a) of the Dodd-Frank Act, the Commission will issue amendments to its rules to conform them to the adjustment to the accredited investor net worth standard made by the Act. However, Section 413(a) provides that the adjustment is effective upon enactment of the Act. When determining net worth for purposes of Securities Act Rules 215 and 501(a)(5), the value of the person’s primary residence must be excluded. Pending implementation of the changes to the Commission’s rules required by the Act, the related amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted from the investor’s net worth.

So, until the Commission completes its rulemaking process and amends Rules 215 and 501(a)(5) of the Securities Act (which you can comment on here):

• If you’re an investor trying to determine whether you’re accredited under the new net worth standard you have to exclude the value of your primary residence from the calculation and, if you have any negative equity (if you’re underwater on your mortgage), you have to further reduce your net worth by that amount of negative equity.

• If you’re a company or fund trying to raise money you should revise your subscription documents to include language that reflects the adjusted net worth standard for individual accredited investors.

(h/t to Kevin for some of the research on this first post)