SEC Finalizes Changes to Accredited Investor Standard
February 12, 2012 § 5 Comments
The Securities and Exchange Commission recently adopted final rules to implement changes to the accredited investor standard required by the Dodd-Frank Act.
Most hedge funds rely on Rule 506 of Regulation D when offering their interests to investors. Rule 506 generally exempts funds from having to register their private securities offerings with the SEC when they sell their interests only to accredited investors. Under the pre-Dodd-Frank standard, individuals were considered accredited investors if they had either a $1,000,000 net worth or satisfied an alternative annual income test.
Upon passage, Dodd-Frank immediately required that the value of an individual’s primary residence be excluded when calculating net worth. The Act instructed the SEC to amend its rules to reflect this exclusion. The SEC’s recent action did that and clarified other elements of the standard.
The SEC declined to adopt a definition of primary residence, relying on the term’s commonly understood meaning–the home where a person lives most of the time. The Commission also clarified that debt on the primary residence would be excluded from the net worth calculation, up to the estimated fair value of the primary residence.
As result of the new standard, many fund managers are finding that the pool of prospective investors has shrunk considerably. Those managers will also find that even their existing investors may no longer meet the accredited investor requirements. The SEC generally declined to adopt transition provisions to grandfather in existing fund investors for later “follow-on” investments except for certain capital calls contemplated at the time of initial investment. Hedge fund managers will need to confirm that their existing investors satisfy the new standard whenever there is a new investment decision.
The final rule changes have an effective date of February 27, 2012. This doesn’t mean much since the net worth standard has been modified since the passage of Dodd-Frank. The SEC must revisit the standard every four years.
Jack G. Martel is the author of Investment Adviser Law Blog which is devoted to providing information and discussion of interest to investment advisers, private fund managers and others in the financial management industry. Jack is a partner in Ragghianti | Freitas LLP. He has over fifteen years experience in general business and securities transactions with a focus on assisting investment advisers, fund sponsors and managers in all manner of legal, regulatory and compliance issues. Jack can be reached at 415.453.9433.