The Revised “Accredited Investor” Standard Under the Dodd-Frank Wall Street Reform Act

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The “accredited investor” status of a potential investor is a crucial element in determining the availability of the safe harbor under private placements and other Regulation D offerings. Previously, Rule 215 and Regulation D defined “accredited investor” as any natural person who satisfied the Net Worth or Income Test.

To qualify as an accredited investor under the Income Test, the investor must have individual income in excess of $200,000 in each of the two previous years or joint income (with his or her spouse) in excess of $300,000 in each of those years. Furthermore, the investor must have a reasonable expectation of reaching those same income levels in the current year. Or to qualify as an accredited investor under the Net Worth test, the investor must have individual net worth, or joint net worth (with his or her spouse), in excess of $1,000,000 at the time of his purchase. This calculation of net worth includes the value of an investor’s primary residence.

Effective as of July 21, 2010, the Dodd-Frank Wall Street Reform Act (the “Act”) has amended the Net Worth test to qualify as an “accredited investor.” Section 413(a) of the Act now amends the definition of “accredited investor” to exclude the value of an investor’s primary residence from the $1 million net worth calculation. The other provisions of the “accredited investor” definition, including the net income test for natural persons, remain unchanged.

It is important to note that the amount of indebtedness secured by the primary residence (i.e. the mortgage) up to its fair market value may also be excluded from the Net Worth calculation. However, any indebtedness secured by the residence in excess of the value of the home will probably be considered a liability and deducted from the investor’s net worth.

This amendment to the accredited investor definition is effective immediately, with no grandfathering for private offerings that have commenced but have yet to close. Accordingly, this will have a severe impact on companies conducting private offerings under Regulation D, including companies, who accept additional subscriptions from existing investors. For such companies, it will be necessary to update their subscription documents and investor questionnaires to ensure that they are in compliance.

The Act’s revised “accredited investor” standard may render ineligible to invest some investors who were previously qualified to invest in private offerings. Companies should pay close attention to such non-qualified investors to avoid mistakenly blowing their applicable exemption from the registration requirements under the Securities Act.

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