Accredited Investor Status in Rule 506 Offerings – Going Public Lawyers

Securities Lawyer 101 Blog

Regulation D under the Securities Act of 1933,
as amended (the “Securities Act”), sets forth a safe harbor from the registration requirements of the Securities Act for certain private placements of securities. In connection with these exemptions, offerings made in reliance upon Regulation D, Rule 504, 505 and 506 can be made to up to 35 non-accredited investors and an unlimited number of “accredited” investors.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) amended the definition of an “accredited” investor to exclude the value of an investor’s primary residence when determining whether the net worth of that person (or joint net worth with his or her spouse) exceeds the $1 million net worth test. The amended rule, established by Dodd Frank became effective on February 27, 2012.

Under the amended rule, for purposes of calculating net worth in determining status of accredited investors, the value of an investor’s primary residence may not be included. The rule also excludes the value of any mortgage or other debt secured by an investor’s primary residence from being deducted as a liability for an investor’s net worth provided that the debt does not exceed the fair market value of the primary residence.

If the debt exceeds the fair market value of the investor’s primary residence, the excess must be included as a liability in calculating the individual’s net worth. Accredited investor status is determined at the time of the sale of securities.

The amended accredited investor definition also requires that any mortgage or other debt that is secured by an individual’s primary residence and incurred within 60 days prior to the determination of accredited investor status under Regulation D (other than a loan used to purchase a primary residence) must be deducted from the investor’s net worth regardless of whether the total mortgage debt exceeds the fair market value of the residence.

The amended definition does not alter the requirements for determining fair market value of an investor’s primary residence and an estimate of fair market value is allowed. If all three of the criteria below are met, the value of an individual’s primary residence may be included when calculating net worth:

• The individual must have held the right to purchase securities on July 20, 2010;

• The individual must have qualified as an accredited investor at the time he or she acquired the right to purchase such securities; and

• On July 20, 2010, the individual must have already owned securities of the issuer other than the right to purchase securities in question.

Issuers contemplating private placement to accredited investors should revise their subscription agreements and other investor questionnaires to state clearly the requirements of the new accredited investor definition. The SEC’s new definition of accredited investor will likely impact Rule 506 offerings of all issuers who conduct securities offerings including SEC reporting and non-reporting issuers who go public direct and undertake direct public offerings and those who pursue reverse mergers with public shells. The rule should also lessen legal and compliance costs for these issuers.