On Dec. 21, 2011, the Securities and Exchange Commission (SEC) issued a final rule1 (the Rule) amending the Accredited Investor Standard in the SEC's rules under the Securities Act of 1933.

These changes were required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and conform the SEC's rules to the changes made to the Accredited Investor Standard when the Dodd-Frank Act was signed into law on July 21, 2010.

The Dodd-Frank Act changed the Accredited Investor Standard by excluding the value of a natural person's primary residence in calculating whether he or she meets the $1 million net worth test for qualifying as an Accredited Investor.

The Rule clarifies two aspects of the Dodd-Frank change. First, the Rule clarifies that: 1) indebtedness that is secured by the person's primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, is not included as a liability (except that if the amount of such indebtedness outstanding at the time of the sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess is included as a liability); and 2) indebtedness that is secured by the person's primary residence in excess of the estimated fair market value of the primary residence is included as a liability.

Second, the Rule allows for limited follow-on investment by persons who met the previous Accredited Investors Standard but who do not meet the new standard. These follow-on investments are only allowed if 1) such a person had a right to make the investment on July 20, 2010; 2) the person was an Accredited Investor on the basis of net worth at the time the person acquired such right; and 3) the person held securities of the same issuer, other than such right, on July 20, 2010.

Importantly, this grandfathering provision only applies to the exercise of statutory rights, such as pre-emptive rights arising under state law; rights arising under an entity's constituent documents; and contractual rights, such as rights to acquire securities upon exercise of an option or warrant or upon conversion of a convertible instrument, rights of first offer or first refusal and contractual pre-emptive rights There is no grandfathering provision for investors in a hedge fund or other private fund unless the investor has one of the specific rights described above (such as through a side letter with the fund).

The Rule will be effective 60 days from publication in the Federal Register.

Footnote

1 See NET WORTH STANDARD FOR ACCREDITED INVESTORS, Release Nos. 33-9287; IA-3341; IC-29891; File No. S7-04-11 (Dec. 21, 2011) http://www.sec.gov/rules/final/2011/33-9287.pdf .

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