“Accredited Investor” Net Worth Standard
A Small Entity Compliance Guide1
Introduction
On December 21, 2011, the Securities and Exchange Commission adopted amendments to the accredited investor standards in its rules under the Securities Act of 1933 to implement the requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as the Dodd-Frank Act). Section 413(a) requires that the value of a person’s primary residence be excluded when determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million.
What are the “accredited investor” standards?
The accredited investor standards are used in determining the availability of certain exemptions from Securities Act registration for nonpublic and limited offerings, including most offerings under Regulation D. The accredited investor concept identifies investors who are eligible to participate in those offerings of unregistered and illiquid securities. In order to rely on investor status as an “accredited investor,” issuers must know or have a reasonable basis to believe that the investor falls within one of eight categories.2 The individual net worth standard is one such category.
What are the requirements for an individual to qualify as an “accredited investor” based on net worth?
- The individual must have a net worth greater than $1 million, either individually or jointly with the individual’s spouse. Except for the special provisions described below, individuals should include all of their assets and all of their liabilities in calculating net worth.
- The primary residence is not counted as an asset in the net worth calculation. The term “primary residence” is not defined in SEC rules but is commonly understood to mean the home where a person lives the most of the time.
- In general, debt secured by the primary residence (such as a mortgage or home equity line of credit) is not counted as a liability in the net worth calculation if the estimated fair market value of the residence is greater than the amount of debt secured by it. There is no requirement to obtain a third party estimate of the fair market value of the residence.
- However, if the amount of debt secured by the residence has increased in the 60 days preceding the sale of securities to the investor (other than in connection with the acquisition of the primary residence), then the amount of that increase is included as a liability in the net worth calculation, even if the estimated value of the residence is greater than the amount of debt secured by it. The purpose of this provision is to deter individuals from incurring debt secured by their primary residence for the purpose of inflating their net worth to qualify as accredited investors in purchasing securities.
- If the amount of debt secured by the primary residence is greater than the estimated fair market value of the residence, then the excess is included as a liability in the net worth calculation. Where the amount of secured debt is greater than the value of the primary residence, such as when a mortgage is “underwater,” the excess is counted as a liability when calculating net worth. This is true even if the borrower may not be personally liable for the excess amount by reason of the contractual terms of the debt or the operation of state anti-deficiency statutes or similar laws.
The primary residence can be included in the net worth calculation for certain follow-on investments
The former accredited investor net worth test, under which the primary residence and indebtedness secured by it are included in the net worth calculation, applies to purchases of securities in accordance with a right to purchase such securities, if:
- The right was held by a person on July 20, 2010, the day before the enactment of the Dodd-Frank Act;
- The person qualified as an accredited investor on the basis of net worth at the time the right was acquired; and
- The person held securities of the same issuer, other than the right, on July 20, 2010.
Examples of accredited investor net worth calculations:
Assume an investor holds the following assets and liabilities as of the date of purchase in a securities offering:
| Assets | Liabilities |
| Primary residence: $1,200,000 | Mortgage/HELOC: $800,000 |
| Other assets: 850,000 | Other debt: 20,000 |
- Basic net worth calculation with positive home equity:
| Assets | Liabilities |
| Primary residence: $ | Mortgage/HELOC: $ |
| Other assets: 850,000 | Other debt: 20,000 |
| Total assets: $ 850,000 | Total liabilities: $ 20,000 |
| Individual’s net worth: $850,000 – $20,000 = $830,000 | |
- Net worth calculation with a recent debt increase: If the amount of the mortgage/home equity line of credit indebtedness has increased within 60 days of the purchase of securities (for example, because of a $10,000 drawdown under the HELOC), then the amount of that increase would be included as a liability in the person’s net worth calculation:
| Assets | Liabilities |
| Primary residence: $ | 60-day increase: $ 10,000 |
| Other assets: 850,000 | Other debt: 20,000 |
| Total assets: $ 850,000 | Total liabilities: $ 30,000 |
| Individual’s net worth: $850,000 – $30,000 = $820,000 | |
- Net worth calculation with negative home equity: If the fair market value of the person’s primary residence fell to $600,000, but the value of the mortgage remained at $800,000, the net worth calculation would be:
| Assets | Liabilities |
| Primary residence: $ | Mortgage >$600,000: $ 200,000 |
| Other assets: 850,000 | Other debt: 20,000 |
| Total assets: $ 850,000 | Total liabilities: $ 220,000 |
| Individual’s net worth: $850,000 – $220,000 = $630,000 | |
Other resources:
The adopting release for the rule amendments implementing the accredited investor net worth standard required by the Dodd-Frank Act can be found on the SEC website at http://www.sec.gov/rules/final/2011/33-9287.pdf.
Section 413(a) of the Dodd-Frank Act can be found at http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/pdf/PLAW-111publ203.pdf
Contacting the SEC
The SEC’s Office of Small Business Policy in the Division of Corporation Finance is available to assist small companies and others with questions regarding these amendments, as well as any other SEC regulatory matters concerning small companies. You can contact that office for this purpose at (202) 551-3460 or [email protected].