Dodd-Frank Act Affects Private Placements by Raising the Bar for Individual Accredited Investors

Lewis J. Geffen and Daniel I. DeWolf of Mintz Levin Cohn Ferris Glovsky & Popeo LLP

With the enactment of the Dodd-Frank Act on July 21, 2010, the "net worth" standard for an "accredited investor" under Regulation D has been adjusted, effective immediately, to specifically exclude the value of a primary residence from an investor's net worth determination under Rule 501(a)(5) of the SEC's private placement safe harbor in Regulation D. This exclusion, immediately effective upon enactment of the Act, without any further action by the SEC, will make it more difficult for natural persons to qualify as accredited investors.

Many companies rely on the safe harbor exemption of Regulation D to permit the sale of securities in private placement transactions to accredited investors, which exempts such transactions from the registration requirements of the federal securities laws. For individuals to qualify as "accredited investors," they must satisfy either income or net worth standards. To meet the income standard, the investor must have income that exceeds $200,000 in each of the two most recent years or joint income with his or her spouse that exceeds $300,000 in each of those years, and have a reasonable expectation of reaching the same income level in the current year. If the investor's income does not exceed these thresholds, he or she must alternatively satisfy the net worth standard.

In the past, the net worth standard depended on whether the investor has an individual net worth, or joint net worth with the investor's spouse, at the time of the investment that exceeds $1,000,000. The value of the investor's primary residence historically has been included as part of the individual's net worth for purposes of determining whether the investor is accredited. With the enactment of the Dodd-Frank Act, however, the value of the investor's primary residence will no longer be included.

Section 413 of the Dodd-Frank Act now requires individual investors to exclude the value of their primary residence in determining whether they have a net worth that exceeds $1,000,000. The SEC has already issued guidance to the effect that any mortgage or other debt secured by the primary residence up to the fair market value of the primary residence is also excluded from the calculation of net worth. If that mortgage or debt, however, exceeds the fair market value of the primary residence, then the excess should be considered a liability and deducted from the investor's net worth.

These changes to the net worth determination are effective immediately, so issuers, investors and others that participate in private placement transactions should make sure that their disclosure documents, accredited investor questionnaires and subscription agreements are consistent with this new standard.

Lewis J. Geffen, Member,

Lewis is a member in the Corporate practice and Co-Chair of the Venture Capital and Emerging Companies practice group, focusing primarily in the areas of venture capital, mergers and acquisitions, corporate law, intellectual property, and securities law. Lewis regularly represents technology-based companies, principally in the areas of biotechnology, biomedical, medtech, networking and communications, Internet, and software. His clients range in size from newly formed start-up ventures to large public companies. He routinely counsels these clients on their growth and development, advises their boards of directors and management, and assists them with a wide range of domestic and international transactions, including venture capital and other private financings, technology licensing, mergers and acquisitions, strategic alliances, and public offerings. Lewis also regularly represents venture capital firms in both fundraising and portfolio investment activities and underwriters in public offerings and private placements of equity and debt securities.

Daniel I. DeWolf, Member,

Daniel is a member in the Corporate practice in the New York office and Co-Chair of the Venture Capital and Emerging Companies practice group. He is also a member of the Sports and Entertainment practice group. Daniel brings a unique blend of talent and expertise to our venture capital and emerging companies practice. In addition to his active legal practice, he is an Adjunct Professor of Law at the NYU Law School and he has a wealth of experience as an active venture capital investor, having co-founded Dawntreader Ventures, an early stage venture capital firm based in New York. Daniel is also the Co-Editor of Venture Capital: Forms and Analysis, a leading treatise on venture capital published by the Law Journal Press. In addition to venture capital, his practice focuses on private equity funds, representing venture-backed companies, corporate governance, and general corporate law.

Mintz Levin

Mintz Levin is an AmLaw 100 firm comprised of 450 attorneys across 15 distinct practice areas with eight offices (Boston, New York, Washington, Stamford, Los Angeles, Palo Alto, San Diego, and London) strategically located to meet the evolving needs of our clients.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances.ÿ For legal advice, please consult your personal lawyer or other appropriate professional. Reprinted with permission from Mintz Levin Cohn Ferris Glovsky & Popeo LLP.