The massive Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), signed by President Obama on July 21, 2010, changes the standards for determining whether an individual is an “accredited investor” for private offerings by companies raising capital. The change became effective immediately upon enactment of Dodd-Frank. Accordingly, companies that may have begun, but not completed, a private offering may have to re-submit investor questionnaires to subscribers prior to closing their offerings. Obviously, any issuer contemplating a private offering in the future will have to comply with the newly-enacted standard.
Rules 505 and 506, adopted by the Securities and Exchange Commission (the “SEC”), permit business-law to raise capital without the expensive and time-consuming process of registering their offerings under the Securities Act of 1933. In particular, those rules permit business-law to issue securities to an unlimited number of accredited investors and up to 35 non-accredited investors. The definition of “accredited investor” includes, among others, an individual who has a net worth in excess of $1,000,000 (either alone or with the individual’s spouse). Prior to Dodd-Frank, a potential investor could include the value of his or her primary residence for determining net worth. Section 413 of Dodd-Frank, however, provides that the value of the potential investor’s primary residence cannot be included for determining net worth.
Dodd-Frank does not define the term “value of the primary residence” of an individual. In addition, the act does not address the effect of a mortgage or other indebtedness, if any, secured by the residence on determining net worth. The staff of the SEC recently offered its interpretation of these issues in a Compliance and Disclosure Interpretation (“CDI”). The CDI states that, for purposes of complying with Dodd-Frank, the “amount of indebtedness secured by the primary residence up to its fair market value may also be excluded. Indebtedness secured by the residence in excess of the value of the home should be considered a liability and deducted from the investor’s net worth.”
These interpretations are not, however, binding on the SEC and come with a heavy disclaimer. As the staff points out, CDI’s reflect only the views of the staff of the Division of Corporation Finance and are not rules, regulations, or statements of the SEC. Further, the SEC “has neither approved nor disapproved these interpretations. These positions do not necessarily contain a discussion of all material considerations necessary to reach the conclusions stated, and they are not binding due to their highly informal nature. Accordingly, these responses are intended as general guidance and should not be relied on as definitive. There can be no assurance that the information presented in these interpretations is current, as the positions expressed may change without notice.” In fact, Dodd-Frank permits (and, beginning four years after its enactment, requires) the SEC to review the definition of “accredited investor” and to make changes to the definition. Accordingly, companies intending to raise capital from accredited investors should follow SEC action in this area for updates or changes.
Dodd-Frank’s change to the determination of net worth will undoubtedly shrink the pool of available investors for issuers contemplating a private offering of securities to accredited investors. Those issuers that target their offerings to individuals who are accredited investors will need to change their disclosure and subscription documents to reflect the change. The same is true for issuers that have begun, but not completed, a private offering, as the Dodd-Frank change became effective upon its enactment (July 21, 2010).