By Lisa S. Miller and Stephanie Chandler

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).  While the primary focus of the Dodd-Frank Act is financial reforms that will not go into effect until one year after the date of enactment, one significant change is effective immediately. This change impacts which investors can participate in a private offering of securities under Regulation D by changing the definition of “accredited investor” under the Securities Act of 1933 (the “Securities Act”).  When conducting a private offering of securities, many issuers rely on the Regulation D safe harbor exemption from the registration requirements of the Securities Act and make such private offerings only to accredited investors in order to avoid onerous disclosure requirements that apply when offerings include unaccredited investors. 

An investor is accredited when certain conditions are met such as having a net worth, or joint net worth with an investor’s spouse, that exceeds $1 million.  The enactment of the Dodd-Frank Act excludes the value of a person’s primary residence from the $1 million net worth test.  The practical effect of this change is that investors who were formerly accredited may no longer meet the requirements, as the net worth test has been effectively increased by this change.  Companies that are currently involved in private offerings and those preparing for a private offering must take note and revise their requirements appropriately.

The Securities and Exchange Commission (“SEC”) requires that both an investor's assets and debts be considered to determine net worth.  Prior to the changes resulting from the Dodd-Frank Act, investors would be able to include only the equity they possessed in their primary residences. Now, it is anticipated that the staff of the SEC, in applying the $1 million net worth test, will allow investors to exclude any mortgage or any other debt secured by the investor’s primary residence that does not exceed the fair market value of the residence.  If, however, the amount of such debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for any deficiency, investors would be required to deduct the excess liability from the net worth calculation.  This is an important consideration in the current housing market, as many investors may have to assess the current value of their homes and may have to recognize a liability that would reduce their net worth.

With the immediate effective date of the Dodd-Frank Act, private offerings currently in progress should be updated, and subscriptions that have been received need to be reviewed to determine if the investor indicated that his accredited investor status was based on a net worth calculation prior to closing.  If the investor is relying on net worth, then the offeror may need to receive supplementary information from the investor.  Further, if you are currently engaged in or preparing to engage in a private offering, we recommend that you consider revising your subscription and offering documents to comply with this new law. 

If you have any questions about the new Accredited Investor Requirements or would like to speak with someone about your private offering, please contact Stephanie Chandler at 210.978.7704 or schandler@jw.com, Lisa Miller at 210.798.7781 or lsmiller@jw.com, or any of the Jackson Walker Corporate & Securities attorneys.