The purpose of this article is to analyze the definition of an “accredited investor” under federal and Arizona securities law, and to provide an overview of the Securities and Exchange Commission’s (“SEC”) recent proposed new rules amending the definition.
I. “Accredited Investor” under Federal Securities Law.
Pursuant to the Securities Act of 1933 (“Securities Act”), an entity that offers and/or sells securities has to register the offering and sale with the SEC
. The Securities Act, however, contains numerous exemptions to this general rule. Id.; see 15 U.S.C. §77d; see also our article, “Securities Registration and Exemptions under Federal and Arizona Law
.” Regulation D – codified at 17 C.F.R. §§ 230.501-230.508 (SEC Rules 501-508) – for example, provides an exemption for entities that offer or sell securities to “accredited investors,” if the offering meets certain additional criteria. Id. The theory behind exemptions such as Regulation D is that sophisticated, wealthy investors need less regulatory protection and access to information, as they have the ability to evaluate the suitability of investments for themselves, as well as the ability to shoulder greater risk than an ordinary investor.
Currently 17 C.F.R. § 230.501(a)/SEC Rule 501(a) and 17 C.F.R. §230.215/SEC Rule 215, define “accredited investor,” as the term applies to individual investors, as follows:
Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000; [or]
Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
Certain types of companies, including banks, employee benefit plans, charitable entities, corporate officers of the issuers, and trusts with assets over $5 million can also qualify as “accredited investors,” but the scope of this article is limited to analyzing the definition of “accredited investor” as it pertains to individuals.
Section 413 also provides that the SEC should review the definition of an “accredited investor” not less than every four (4) years, but only after July 21, 2014, “to determine whether the requirements of the definition should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy.” Additionally, under Section 415 of Dodd-Frank, the Comptroller General of the United States shall study current thresholds for “accredited investors,” and must submit a report to Congress with its findings
no later than July 21, 2013. The exact language of the applicable rules and regulations has not yet been amended, and is the subject of an SEC proposed rule change, discussed in Section II of this Article.
Prior to Dodd-Frank, the net worth threshold included in the definition of “accredited investor”
had not been adjusted since it was set in 1982. In 1982, the percentage of the American population who met the net worth threshold was 1.3%. Id. By 2010, that percentage rose to 9.04%. Id. The change to the definition of an “accredited investor” under Dodd-Frank “is aimed at protecting those who have seen the value of their homes appreciate over time but are relatively unsophisticated investors. In other words, it is intended to keep average investors who are ‘house rich’ from jeopardizing their financial security by investing money they cannot afford to lose.” Id.
II. SEC's Recent Proposed Rule Changes.
To formally effectuate the changes required by Section 413 of Dodd-Frank to the definition of “accredited investor,” the SEC issued a proposed rule change on January 25, 2011. (See the full text of the SEC’s release
.) The SEC proposes the following amended definition of “accredited investor” with respect to net worth:
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.
Id. at 7.
The SEC has also opined that “[t]he conventional or commonly understood meaning of the term [net worth] is the difference between the value of a person’s assets and the value of the person’s liabilities.” Id. at 6-7.
Under this amended definition, not only would individuals not be able to use the equity they have in their primary residence to qualify as an “accredited investor,” but if a primary residence’s fair market value is less than the amount of the mortgage(s) on the primary residence, the difference will be subtracted from the individual or couple’s net worth. See SEC
. If the mortgage(s) on the primary home does not exceed the fair market value, however, the mortgage need not be considered a liability for the purpose of calculating an individual or couple’s net worth. Id.
The SEC declined to propose an exact definition for the term “primary residence,” instead stating that “[i]ssuers and investors should be able to use the commonly understood meaning of ‘primary residence’
– the home where a person lives most of the time.”
III. “Accredited Investor” under Arizona Securities Law.
In addition to complying with federal securities laws, issuers of securities also have to comply with state securities laws, including their registration provisions.
A.R.S. § 44-1845 permits the Arizona Corporation Commission to create exemptions from registration under the Arizona Securities Act “if it finds that registration of such securities under this chapter is not necessary in the public interest and for the protection of investors by reason of the special characteristics of the securities or transactions, the small amount involved or the limited character of the offering.” Registration exemptions related to “accredited investors” are found in Rule 126 (R14-4-126) and Rule 140 (R14-4-140) of the Arizona Administrative Code.
An “accredited investor” under the Arizona Administrative Code, again relating only to individuals, is nearly identical to the pre-Dodd-Frank federal regulations:
e. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of that person’s purchase exceeds $1,000,000;
f. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
R14-4-126(B)(1)(e),(f); see also R14-4-140(A)(1).
At least one state, Oregon, has proposed an amendment to its administrative rules to mirror its definition of “accredited investor” with the SEC’s proposed rule. See also Minnesota
. It is unclear at this time whether Arizona will follow suit.
If you have questions regarding a possible securities law matter, or to arrange for a consultation concerning your legal matter, please contact Robert Mitchell at email@example.com or at (602) 452-2730.