The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act") changed the definition of "Accredited Investor" by subtracting the value of an investor's primary residence from the calculation of "net worth." The staff of the SEC's Division of Corporation Finance issued an interpretation of this statute clarifying that debt secured by an investor's primary residence (up to the fair market value of the residence) may also be excluded from the investor's net worth. In other words, an investor would not be allowed to include the value of her home as part of her net worth, but the investor also would not be required to deduct the mortgage debt from her net worth.
On January 25, 2011, the SEC proposed a rule that incorporates the new law and SEC staff interpretation into the relevant regulation. Specifically, the new regulation would define accredited investor as follows:
Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of purchase, exceeds $1,000,000, excluding the value of the primary residence of such natural person, calculated by subtracting from the estimated fair market value of the property the amount of debt secured by the property, up to the estimated fair market value of the property.
The proposed rule does not define "primary residence." The release accompanying the proposed regulation explains that the SEC opted to avoid unnecessary complexity by relying on the term's commonly understood meaning, that is, the home where a person lives most of the time. Nor does the new rule address how an investor determines the fair market value of this home.
The SEC addresses the fact that the proposed rule would favor non-mortgage debt over mortgage debt. An investor with $2 million in total assets, including an unencumbered primary residence worth $1 million, and unsecured debt of $500,000, would have a net worth under the new definition of $500,000. Another investor with the same assets, home value and unsecured debt, but with a mortgage of $1 million would have a net worth under the rule of $1.5 million.
The SEC is undoubtedly busy digging out from the blizzard of studies and rulemaking dumped on it by Congress, so perhaps an enterprising practitioner will suggest a formula for calculating an investor's net worth that eliminates the apparent incentive for investors to increase their mortgage debt. The SEC is soliciting comments on these and any other elements of the proposed rule, and interested parties may submit comments through March 11, 2011.
For more information, please call a member of our Securities Practice Group.
