Dodd-Frank Reform Act Triggers Immediate Change in Regulation D "Accredited Investor" Definition
In response to the significant financial difficulties experienced over the past three years, on July 21, 2010 President Obama signed into law sweeping financial services reform legislation entitled the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act").1 Running over 2,000 pages, the Act is designed to effect a broad range of reforms to the U.S. financial regulatory system. Although many provisions of the Act are not scheduled to take effect until one year after enactment or until regulatory bodies first adopt rules and regulations to implement the Act's requirements, one provision of the Act is effective immediately: a provision that excludes the value of a natural person's primary residence when determining if he or she meets the $1 million net worth test in order to qualify as an "accredited investor" under Regulation D, the securities law provision governing private placements. As a practical consequence, subscription documents and investment representations and procedures for ongoing and future private offerings should be revised immediately.
Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D contains various exemptions from the registration requirements which are typically used to conduct private placements, including by private equity, venture, hedge and other funds and investment vehicles. Regulation D offerings are usually made only to investors that qualify as "accredited investors" in order to avoid specific disclosure requirements that apply when such offerings include any unaccredited investors. Regulation D sets forth alternative, non-exclusive, tests for determining "accredited investor" status, one of which is if a natural person possesses an individual net worth exceeding $1 million. Until now, the value of an investor's primary residence was included in making this calculation. However, effective immediately, under Section 413(a) of the Act, the value of a person's primary residence may no longer be included when determining a person's net worth for "accredited investor" purposes. The other provisions of the "accredited investor" definition remain unchanged at this time.
Additionally, after four years from the date of the Act's enactment and not less than once every four years thereafter, the SEC must review the "accredited investor" definition as it applies to natural persons and may make such adjustments, by normal notice and comment rulemaking, as it deems appropriate "for the protection of investors, in the public interest, and in light of the economy."
What to Do?
This change will effectively increase the net worth requirement for many investors that are natural persons. Because Regulation D requires that "accredited investor" status is determined and documented at the time of investment, investors relying on the $1 million net worth test should confirm that their net worth is calculated without including the value of their primary residence. Additionally, any issuer currently conducting a Regulation D offering should determine if any potential investors are relying exclusively upon the $1 million net worth test and have any such investors confirm and document that their net worth exceeds $1 million without regard to the value of their primary residence. Issuers also will need to revise their standard forms of subscription documents to reflect the new net worth requirement for all future offerings.
If you have any questions concerning the matters described in this Alert please contact:
1. The Dodd-Frank Wall Street Reform and Consumer Protection Act is available at: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173enr.txt.pdf
This Alert has been prepared for general informational purposes only and is not intended as specific legal advice and no legal or business decision should be based solely on its content.