The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Reform Act") was signed on July 21, 2010. Although the Reform Act includes or promises significant future changes to various securities laws and regulations, it includes one immediate change. Upon the Reform Act's effectiveness, one element of the definition of "accredited investor" was changed: The value of the primary residence of an individual or natural person may no longer be counted to satisfy the $1 million net-worth test of an individual accredited investor.
Issuers conducting private offerings of securities to raise capital or to make acquisitions often rely on Regulation D as the exemption from the registration requirements of the federal Securities Act of 1933. Characterization of an investor or a prospective investor in a private offering as an accredited investor can be important for the exemption for, and the time and expense required to conduct, the offering.
An individual or natural person may be an accredited investor, as defined in Regulation D, by satisfying one of two possible tests:
- Having individually, or jointly with his or her spouse, a net worth of at least $1 million.
- Having annual income in each of the last two years, and reasonably expecting annual income in the current year, of at least $200,000 individually or at least $300,000 with his or her spouse.
The Reform Act does not change the statement or the text of either test, or address the interpretation of the annual-income test. It provides for an immediate change only in the interpretation or calculation of the net-worth test. By excluding the value of an individual's primary residence, the Reform Act makes it more difficult to satisfy that test.
The Reform Act does not address whether a mortgage or other debt secured by an individual's primary residence is also to be excluded from the net-worth calculation. The staff of the Securities and Exchange Commission, however, has published an interpretation stating that, until addressed in a future rule adopted by the SEC, a mortgage or similar debt should be so excluded to the extent that the mortgage or other debt does not exceed the fair market value of the residence.
These changes apply not only to any future private offering, but also to any private offering now in process (including an offering in which there has been an initial closing). Accordingly, an issuer now conducting a private offering in reliance on Regulation D should at least:
- Revise or supplement its disclosure and subscription documents to reflect the changes in the net-worth test.
- Determine whether each accredited investor who has subscribed remains accredited in accordance with the changed net-worth test, if necessary. This may require obtaining additional representations on other information to ensure that the net-worth test, if applicable, is satisfied.
The net-worth test does not itself apply directly to any investor or prospective investor that is not an individual. Nevertheless, issuers should be mindful that the changes in the net-worth test might affect the accredited investor status of an entity deemed accredited only because all of its owners are accredited, if some or all of those owners are individuals.
For more information, please contact Richard A. Tulli in our Dallas office ([email protected] or 214.999.4676), Eric A. Blumrosen in our Houston office ([email protected] or 713.276.5533), or any other member of the Gardere's Securities Team.
