Document ID: SEC-2011-2045-0001
Agency: sec
Document Type: Rule
Title: Net Worth Standard for Accredited Investors
Posted Date: 2011-12-29T05:00Z

[Federal Register Volume 76, Number 250 (Thursday, December 29, 2011)]
[Rules and Regulations]
[Pages 81793-81806]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-33333]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270, and 275

[Release Nos. 33-9287; IA-3341; IC-29891; File No. S7-04-11]
RIN 3235-AK90

Net Worth Standard for Accredited Investors

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting amendments to the accredited investor 
standards in our rules under the Securities Act of 1933 to implement 
the requirements of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act. The Act requires the definitions of ``accredited 
investor'' in our Securities Act rules to exclude the value of a 
person's primary residence for purposes of determining whether the 
person qualifies as an ``accredited investor'' on the basis of having a 
net worth in excess of $1 million. This change to the net worth 
standard was effective upon enactment by operation of the Dodd-Frank 
Act, but it also requires us to revise our current Securities Act rules 
to conform to the new standard. We also are adopting technical 
amendments to Form D and a number of our rules to conform them to

[[Page 81794]]

the requirements of the Act and to correct cross-references to former 
Section 4(6) of the Securities Act, which was renumbered Section 4(5) 
by Section 944 of the Dodd-Frank Act.

DATES: Effective date: February 27, 2012.

FOR FURTHER INFORMATION CONTACT: Anthony G. Barone, Special Counsel; 
Karen C. Wiedemann, Attorney Fellow; or Gerald J. Laporte, Chief; 
Office of Small Business Policy, Division of Corporation Finance, U.S. 
Securities and Exchange Commission, 100 F Street NE., Washington, DC 
20549-3628, (202) 551-3460.

SUPPLEMENTARY INFORMATION: We are adopting amendments to Rule 
144(a)(3)(viii),\1\ Rule 155(a),\2\ Rule 215,\3\ and Rule 501(a)(5) \4\ 
and 501(e)(1)(i) of Regulation D \5\ of our general rules under the 
Securities Act of 1933 (``Securities Act'') \6\; Rule 500(a)(1) \7\ of 
our Securities Act form rules; Form D \8\ under the Securities Act; 
Rule 17j-1(a)(8) \9\ under the Investment Company Act of 1940; \10\ and 
Rule 204A-1(e)(7) \11\ under the Investment Advisers Act of 1940.\12\
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    \1\ 17 CFR 230.144(a)(3)(viii).
    \2\ 17 CFR 230.155(a).
    \3\ 17 CFR 230.215.
    \4\ 17 CFR 230.501(a)(5).
    \5\ 17 CFR 230.501 through 230.508.
    \6\ 15 U.S.C. 77a et seq.
    \7\ 17 CFR 239.500(a)(1).
    \8\ 17 CFR 239.500.
    \9\ 17 CFR 270.17j-1(a)(8).
    \10\ 15 U.S.C. 80a-1 et seq.
    \11\ 17 CFR 275.204A-1(e)(7).
    \12\ 15 U.S.C. 80b-1 et seq.
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Table of Contents

I. Background and Summary
II. Discussion
    A. Net Worth Standard for Accredited Investors
    (1) Overview of the Amended Rules
    (2) Treatment of Mortgage Debt
    (3) Increases in Mortgage Debt in the 60 Days Before Sale of 
Securities
    (4) Transition Rules
    (5) Other Issues Considered
    B. Technical and Conforming Amendments
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation
VI. Final Regulatory Flexibility Act Analysis
VII. Statutory Authority and Text of the Amendments

I. Background and Summary

    On January 25, 2011, we proposed amendments to the accredited 
investor standards in our rules under the Securities Act of 1933 \13\ 
to implement the requirements of Section 413(a) of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act (the ``Dodd-Frank Act'').\14\ 
The accredited investor standards, which are set forth in Rules 215 and 
501 under the Securities Act, are used in determining the availability 
of certain exemptions from Securities Act registration for private and 
other limited offerings. Section 4(5) of the Securities Act exempts 
transactions involving offers or sales by an issuer solely to one or 
more accredited investors, if the aggregate offering price does not 
exceed $5,000,000, there is no advertising or public solicitation in 
connection with the transaction, and the issuer files a notice with the 
Commission. Pursuant to Regulation D under the Securities Act, an 
issuer conducting a limited offering of securities pursuant to the safe 
harbor of Rule 505 or 506 does not have to comply with the information 
requirements of Rule 502(b) if sales are made only to accredited 
investors; and sales to accredited investors do not count towards the 
35-purchaser limits under Rules 505 and 506.\15\ Moreover, accredited 
investor status obviates the sophistication requirement that Rule 506 
imposes on non-accredited investors.\16\ One purpose of the accredited 
investor concept is to identify persons who can bear the economic risk 
of an investment in unregistered securities, including the ability to 
hold unregistered (and therefore less liquid) securities for an 
indefinite period and, if necessary, to afford a complete loss of such 
investment.\17\
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    \13\ See Net Worth Standard for Accredited Investors, Release 
No. 33-9177 (Jan. 25, 2011) [76 FR 5307] (the ``Proposing 
Release'').
    \14\ Public Law 111-203, 124 Stat. 1376 (July 21, 2010).
    \15\ See note 26 below.
    \16\ Under Rule 506, each purchaser who is not an accredited 
investor must, either alone or with a purchaser representative, have 
such knowledge and experience in financial and business matters that 
he or she is capable of evaluating the merits and risks of the 
prospective investment. 17 CFR 230.506(b)(2)(ii).
    \17\ See, Release No. 33-5487 [39 FR 15261] (1974), at 15264 
(discussing the previous safe harbor for private placements under 
Rule 146), and Release No. 33-6339 [46 FR 41791] (1981), at 41793 
(noting that the accredited investor concept was intended to 
``eliminat[e] the need for subjective judgments by the issuer about 
* * * suitability'', because investors that met the definition of 
accredited investor would be ``presumed to meet the purchase 
qualifications'').
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    Section 413(a) of the Dodd-Frank Act requires us to adjust the 
accredited investor net worth standard that applies to natural persons 
individually, or jointly with their spouse, to ``more than $1,000,000 * 
* * excluding the value of the primary residence.'' \18\ Previously, 
this standard required a minimum net worth of more than $1,000,000, but 
permitted the primary residence to be included in calculating net 
worth.\19\ Under Section 413(a), the change to remove the value of the 
primary residence from the net worth calculation became effective upon 
enactment of the Dodd-Frank Act. As discussed in detail below, we are 
adopting amendments to our rules to conform them to the new standard.
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    \18\ The text of Section 413(a) states that: ``The Commission 
shall adjust any net worth standard for an accredited investor, as 
set forth in the rules of the Commission under the Securities Act of 
1933, so that the individual net worth of any natural person, or 
joint net worth with the spouse of that person, at the time of 
purchase, is more than $1,000,000 (as such amount is adjusted 
periodically by rule of the Commission), excluding the value of the 
primary residence of such natural person, except that during the 4-
year period that begins on the date of enactment of this Act, any 
net worth standard shall be $1,000,000, excluding the value of the 
primary residence of such natural person.'' Id.
    \19\ See 17 CFR 230.215(e) and 230.501(a)(5) (2010).
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    In the Proposing Release, we requested comment in nine specific 
areas. We received 43 comment letters in response.\20\ In addition, we 
received 15 letters commenting on Section 413(a) of the Dodd-Frank Act 
before the publication of the Proposing Release.\21\ These two sets of 
letters came from a variety of groups and constituencies, including 
state regulators, professional and trade associations, individual 
investors, broker-dealers and investment advisers, fund managers, 
consultants, academics and lawyers. Most comment letters expressed 
general support for the proposed amendments and the objectives that we 
articulated in the Proposing Release but suggested modifications to the 
proposals. The final rules reflect changes made in response to these 
comments, as well as other clarifying changes. As described in detail 
in the release, the most significant revisions from the proposal 
include the addition of (1) a grandfathering provision that permits the 
application of the former accredited investor net worth test in certain 
limited circumstances and (2) a provision addressing the treatment of 
incremental debt secured

[[Page 81795]]

by the primary residence that is incurred in the 60 days before the 
sale of securities to the individual. Finally, the language of the 
proposed rules has been revised to make them clearer and easier to 
apply.
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    \20\ The comment letters we received on the Proposing Release 
are available on our Web site at http://www.sec.gov/comments/s7-04-11/s70411.shtml. In this release, we refer to these letters as the 
``comment letters'' to differentiate them from the ``advance comment 
letters'' described in footnote 21.
    \21\ To facilitate public input on its Dodd-Frank Act rulemaking 
before issuance of rule proposals, the Commission provided a series 
of email links, organized by topic, on its Web site at http://www.sec.gov/spotlight/regreformcomments.shtml. In this release, we 
refer to letters we received in response to this invitation as 
``advance comment letters.'' The advance comment letters we received 
in anticipation of this rule proposal are available at http://www.sec.gov/comments/df-title-iv/accredited-investor/accredited-investor.shtml.
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    Section 413(b) specifically authorizes us to undertake a review of 
the definition of the term ``accredited investor'' as it applies to 
natural persons, and requires us to undertake a review of the 
definition in its entirety every four years, beginning four years after 
enactment of the Dodd-Frank Act. We are also authorized to engage in 
rulemaking to make adjustments to the definition after each such 
review. Section 415 of the Dodd-Frank Act requires the Comptroller 
General of the United States to conduct a ``Study and Report on 
Accredited Investors'' examining ``the appropriate criteria for 
determining the financial thresholds or other criteria needed to 
qualify for accredited investor status and eligibility to invest in 
private funds.'' \22\ The study is due three years after enactment of 
the legislation. We expect that the results of this study will be taken 
into account in any rulemaking that takes place in this area after the 
study is completed. Accordingly, we did not propose, and we are not 
adopting, any amendments to the definitions of ``accredited investor'' 
that are not related to Section 413(a) of the Dodd-Frank Act at this 
time.
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    \22\ Public Law 111-203, Sec.  415, 124 Stat. 1376, 1578 (to be 
codified at 15 U.S.C. 80b-18c).
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    In addition to the changes to the definition of ``accredited 
investor'' to implement the requirements of Section 413(a), we are also 
adopting today technical amendments to update cross-references that 
have changed as a result of the deletion of former Section 4(5) of the 
Securities Act and the renumbering of former Section 4(6) as Section 
4(5).\23\
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    \23\ Public Law 111-203, Sec.  944, 124 Stat. 1376, 1897 
(renumbering Securities Act Section 4(6), 15 U.S.C. 77d(6) (2006), 
as Section 4(5), 15 U.S.C. 77d(5)). Former Section 4(5) exempted 
transactions involving mortgages with a minimum aggregate sales 
price per purchaser of $250,000, as well as the resales of those 
securities. 15 U.S.C. 77d(6) (2006).
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II. Discussion

A. Net Worth Standard for Accredited Investors

(1) Overview of the Amended Rules
    As discussed above, Section 413(a) of the Dodd-Frank Act requires 
us to adjust the accredited investor net worth standard \24\ that 
applies under our Securities Act rules to natural persons individually, 
or jointly with their spouse, to ``more than $1,000,000 * * * excluding 
the value of the primary residence.'' Previously, the standard required 
a minimum net worth of more than $1,000,000, but permitted the primary 
residence to be included in calculating net worth.
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    \24\ Neither the Securities Act nor our rules promulgated under 
the Securities Act define the term ``net worth.'' The commonly 
understood, or basic, meaning of the term is the difference between 
the value of a person's assets and the value of the person's 
liabilities. See, e.g., Barron's Financial Guides, Dictionary of 
Finance and Investment Terms, at 457 (7th ed. 2006).
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    The relevant rules are Securities Act Rules 501 and 215.\25\ Rule 
501 defines the term ``accredited investor'' for purposes of non-public 
and limited offerings under Rules 504(b)(1)(iii), 505 and 506 of 
Regulation D.\26\ The definition of ``accredited investor'' includes 
persons who come within any of eight listed categories, or whom the 
issuer reasonably believes come within one of those categories, at the 
time of the sale of securities to that person.\27\ The $1 million 
individual net worth standard is one such category.\28\
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    \25\ 17 CFR 230.501(a)(5) and 230.215(e).
    \26\ Under Regulation D, issuers are subject to fewer regulatory 
requirements when the purchasers of their securities are accredited 
investors. Both Rule 505 and Rule 506 require that there be no more 
than, or the issuer reasonably believe there are no more than, 35 
purchasers of securities in the offering. 17 CFR 230.505(b)(2)(ii) 
and 230.506(b)(2)(i). However, Rule 501(e) provides that accredited 
investors are not counted as purchasers for that purpose, with the 
result that an unlimited number of accredited investors may 
participate in an offering under Rule 505 or 506, provided that the 
other requirements of the rules are satisfied. Further, specific 
information requirements apply to issuers in Rule 505 and Rule 506 
transactions if they sell to non-accredited investors, but not if 
they sell only to accredited investors. 17 CFR 230.502(b)(1). Thus, 
issuers in offerings under Rule 505 or 506 generally seek to 
establish that potential purchasers in the offering are accredited 
investors. In addition, Rule 504(b)(1)(iii) exempts offerings from 
the manner of offering and resale restrictions that generally apply 
under Rule 504, if they are made in accordance with certain state 
law exemptions from registration that limit sales to accredited 
investors. 17 CFR 230.504(b)(1)(iii).
    \27\ 17 CFR 230.501(a).
    \28\ Other categories include certain regulated financial 
institutions; certain entities with total assets in excess of $5 
million; directors, executive officers and general partners of the 
issuer or its general partner; and natural persons who had an income 
of at least $200,000 in each of the two most recent years (or 
$300,000 together with their spouse) and have a reasonable 
expectation of reaching the same income level in the current year. 
Id.
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    Rule 215 defines the term ``accredited investor'' under Section 
2(a)(15) of the Securities Act.\29\ Section 2(a)(15) and Rule 215 set 
the standards for accredited investor status under Section 4(5) of the 
Securities Act, formerly Section 4(6), which permits offerings solely 
to accredited investors of up to $5 million, subject to certain 
conditions.\30\ While Regulation D is frequently relied upon,\31\ 
exclusive reliance on Section 4(5) is rare.\32\
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    \29\ 15 U.S.C. 77b(a)(15).
    \30\ 15 U.S.C. 77d(5). As discussed above, former Section 4(6) 
of the Securities Act was renumbered Section 4(5) by Section 944 of 
the Dodd-Frank Act.
    \31\ In fiscal year 2010, we received 16,856 initial filings on 
Form D notifying us of claims of exemption under Rules 
504(b)(1)(iii), 505 and 506, 17 CFR 230.504(b)(1)(iii), 230.505 and 
230.506, the three exemptive provisions in Regulation D where 
accredited investor status affects the availability of an exemption. 
This represented 96% of the 17,593 initial Form D filings we 
received for that year.
    \32\ In fiscal year 2010, we received 900 initial filings on 
Form D notifying us of a claim of exemption under Section 4(5), 
formerly Section 4(6), representing 5% of the 17,593 initial Form D 
filings we received for that year. Only 66 of those filings, or less 
than 0.4% of total initial Form D filings, claimed the Section 4(5) 
exemption exclusively. The other 834 of these Form D filings 
indicated that both Section 4(5) and a Regulation D exemption were 
being relied upon.
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    Historically, the accredited investor standards under Rule 215 and 
Rule 501 have been identical. We are adopting identical language in the 
amendments to Rule 501 and Rule 215, so the two rules will implement 
Section 413(a) of the Dodd-Frank Act in the same way. As amended, the 
new individual net worth standard in the accredited investor definition 
is:

    Any natural person whose individual net worth, or joint net 
worth with that person's spouse, exceeds $1,000,000.
    (1) Except as provided in paragraph (2) of this section, for 
purposes of calculating net worth under this paragraph:
    (i) The person's primary residence shall not be included as an 
asset;
    (ii) 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, shall not be 
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 shall be included as a liability); and
    (iii) Indebtedness that is secured by the person's primary 
residence in excess of the estimated fair market value of the 
primary residence at the time of the sale of securities shall be 
included as a liability.
    (2) Paragraph (1) of this section will not apply to any 
calculation of a person's net worth made in connection with a 
purchase of securities in accordance with a right to purchase such 
securities, provided that:
    (i) Such right was held by the person on July 20, 2010;
    (ii) The person qualified as an accredited investor on the basis 
of net worth at the time the person acquired such right; and
    (iii) The person held securities of the same issuer, other than 
such right, on July 20, 2010.

    The final accredited investor definition is consistent with the 
approach taken in the Proposing Release with respect to the basic 
treatment of the primary residence and indebtedness

[[Page 81796]]

secured by the primary residence.\33\ We have revised the language of 
this provision to make it easier for issuers, investors and other 
market participants to apply the new net worth standard.\34\ We have 
also included a provision addressing the treatment of incremental debt 
secured by the primary residence that is incurred in the 60 days before 
the sale of securities to the individual, and have revised the proposal 
so that that the prior accredited investor net worth test will apply in 
connection with the exercise of rights to acquire securities, so long 
as the rights were in existence on July 20, 2010, the day before 
enactment of the Dodd-Frank Act, the investor qualified as an 
accredited investor on the basis of net worth at the time the rights 
were acquired, and the investor held securities of the same issuer, 
other than the rights, on July 20, 2010.
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    \33\ It is also consistent with the staff's initial analysis of 
Section 413(a). See Securities Act Rules Compliance & Disclosure 
Interpretation, Question No. 255.47 (July 23, 2010) (available at 
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#255.47).
    \34\ We have also deleted a reference to measuring net worth at 
the time of the investor's purchase, as all standards under the 
accredited investor definition are measured ``at the time of the 
sale of securities to that person.'' 17 CFR 230.501(a).
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(2) Treatment of Mortgage Debt
    Under the final rules, as in the Proposing Release, individuals' 
net worth will be calculated excluding any positive equity they may 
have in their primary residence.\35\ As we discussed in the Proposing 
Release, we believe this approach is the most appropriate way to 
conform our rules to Section 413(a). It reduces the net worth measure 
by the net amount that the primary residence contributed to net worth 
before enactment of Section 413(a), which we believe is what is 
commonly meant by ``the value of a person's primary residence.'' Most 
comment letters supported defining ``excluding the value of the primary 
residence'' in this way.\36\
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    \35\ Thus, for example, if an investor with a net worth of $2 
million (calculated in the conventional manner before the enactment 
of Section 413(a)--that is, by subtracting from the investor's total 
assets, including primary residence, the investor's total 
liabilities, including indebtedness secured by the residence) has a 
primary residence with an estimated fair market value of $1.2 
million and a mortgage loan of $800,000, the investor's net worth 
for purposes of the new accredited investor standard is $1.6 
million. Before enactment of Section 413(a), the primary residence 
would have contributed a net amount of $400,000 to the investor's 
net worth for purposes of the accredited investor net worth 
standard--the value of the primary residence ($1.2 million) less the 
mortgage loan ($800,000). Under the amendments, exclusion of the 
value of the primary residence would reduce the investor's net worth 
by the same $400,000 amount.
    \36\ See, e.g., comment letters from Business Law Section of the 
American Bar Association (``ABA''), Cornell Securities Law Clinic 
(``Cornell''), Investment Adviser Association (``IAA''), Managed 
Funds Association, North American Securities Administrators 
Association (``NASAA''), Public Investors Arbitration Bar 
Association and Sullivan & Cromwell LLP (``S&C'').
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    Three letters supported excluding the fair market value of the 
primary residence from net worth without excluding any associated 
debt.\37\ This group of letters argued that our proposal to ``net out'' 
any associated debt from the fair market value of the primary residence 
misinterprets the plain language of Section 413(a), and incentivizes 
investors to increase the amount of debt secured by their primary 
residence to acquire other assets for the purpose of inflating their 
net worth as calculated under our rules. As we stated in the Proposing 
Release, we believe that reducing an investor's net worth by the value 
of the primary residence without also excluding associated indebtedness 
would not accord with the manner in which net worth reflected home 
equity before enactment of Section 413(a); excluding the residence 
alone would reduce net worth by more than the amount the residence 
contributes. We believe the approach in the final rule is the most 
appropriate approach and is consistent with Section 413(a).\38\
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    \37\ See comment letters from Secretary of the Commonwealth of 
Massachusetts (``Massachusetts Securities Division''), Professors 
Manning G. Warren and Marc I. Steinberg; and David A. Marion.
    \38\ New paragraph (ii) of the final rule, discussed in Part 
I.A.2 below, prohibits excluding incremental indebtedness secured by 
the primary residence that is incurred in the 60 days before the 
sale of securities. We believe this provision will mitigate 
incentives to increase debt secured against the residence solely for 
purposes of qualifying as an accredited investor.
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    Five comment letters advocated excluding from the net worth 
calculation both the fair market value of the primary residence and all 
indebtedness secured by the primary residence, regardless of whether 
such indebtedness exceeds the fair market value of the primary 
residence.\39\ Several of these commentators disagreed with our 
proposal on the basis that the proposal would require an estimate of 
the fair market value of the primary residence which, in their view, 
would make the net worth calculation problematic and uncertain and 
would force investors to incur additional expense to obtain a third 
party appraisal of their residence. These commentators argued that 
excluding both the value of the primary residence and all indebtedness 
secured by the primary residence would simplify and provide greater 
certainty regarding the net worth calculation.
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    \39\ See comment letters from Welton E. Blount, Investment 
Program Association (``IPA''), Real Estate Investment Securities 
Association (``REISA''), Steven J. Thayer and Georg Merkl. See also 
advance comment letters from April Hamlin and Michael Scillia.
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    We disagree with this view, as did many commentators.\40\ In the 
first instance, estimating the value of the primary residence did not 
appear to cause problems before the Dodd-Frank Act, when that value was 
included in net worth for purposes of the definition of accredited 
investor. The rules did not then, and the rules we adopt today do not 
now, require a third party opinion on valuation, either for the primary 
residence or for any other assets or liabilities. All that is required 
is an estimate of fair market value.\41\ Further, as we explained in 
the Proposing Release, if the amount of mortgage debt exceeds the value 
of the primary residence (i.e., an underwater mortgage), excluding the 
entire debt from net worth for purposes of the accredited investor 
definition would result in a higher net worth than under a basic net 
worth calculation that takes into account all assets and all 
liabilities. Net worth would be effectively increased by the amount by 
which the mortgage exceeds the value of the primary residence, because 
that excess amount is treated as a liability in a basic net worth 
calculation but would be excluded under the standard proposed by these 
commentators. We do not believe it would be appropriate for us to 
implement Section 413(a) in a way that results in increased net worth 
compared to a basic calculation for individuals with underwater 
mortgages.\42\
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    \40\ See, e.g., letters from Massachusetts Securities Division, 
Cornell, International Association of Small Broker Dealers and 
Advisors, NASAA and the Public Investors Arbitration Association.
    \41\ See, e.g., Release No. 33-6455 (Mar. 3, 1983) at Question 
21 (confirming that, under the net worth standard in effect at the 
time, ``the estimated fair market value'' of a primary residence 
could be considered as an asset) and Question 45 (individual 
statement of net worth reflects estimated value of assets and 
liabilities).
    \42\ Where the amount of debt secured by the primary residence 
exceeds the estimated value of the residence, the new rules will not 
trigger any adjustment to net worth as calculated before the 
enactment of Section 413(a). In a pre-Section 413(a) basic net worth 
calculation involving an underwater mortgage, the fair market value 
of the residence and the amount of the mortgage up to that fair 
market value are included in the calculation but net to zero, and 
the excess of the amount of the mortgage over the fair market value 
of the primary residence is included as a liability. Under the final 
rules, the fair market value of the residence and the amount of the 
mortgage up to that fair market value are excluded from the 
calculation, and the excess of the amount of the mortgage over the 
fair market value of the primary residence is included as a 
liability. In both cases, the overall impact on net worth is a 
reduction equal to the underwater amount (i.e., the excess of the 
amount of the mortgage over the fair market value of the residence). 
Take, for example, an investor whose primary residence has an 
estimated fair market value of $1.2 million, with a mortgage of $1.4 
million. The excess of mortgage loan over the fair market value of 
the primary residence (in this case, $200,000) would be taken into 
account as a liability and serve to reduce net worth both under a 
conventional net worth calculation and under the accredited investor 
definition adopted today. If, on the other hand, all debt secured by 
the primary residence were excluded, including debt in excess of the 
estimated fair market value of the residence, the investor's net 
worth would be $200,000 higher than under a conventional calculation 
because the mortgage debt in excess of the value of the primary 
residence would not be treated as a liability.

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[[Page 81797]]

    Three comment letters argued that mortgage debt in excess of the 
value of the primary residence should be excluded from the net worth 
calculation if the borrower would not be subject to personal liability 
by reason of contractual terms or state anti-deficiency statutes or 
similar laws.\43\ In these situations, indebtedness in excess of the 
value of the residence may not be legally collectible, either because 
the loan by its terms provides recourse only to the underlying asset, 
the residence, or because applicable law bars a lender from obtaining a 
judgment for the shortfall when the fair market value of the residence 
(or the price obtained in a foreclosure sale) is less than the loan 
amount.\44\
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    \43\ See comment letters from ABA and IPA and advance comment 
letter from Keith P. Bishop.
    \44\ See Ghent, Andra C. and Kudlyak, Marianna, ``Recourse and 
Residential Mortgage Default: Theory and Evidence from U.S. 
States,'' (February 25, 2011), Federal Reserve Bank of Richmond 
Working Paper No. 09-10R. Available at SSRN: http://ssrn.com/abstract=1432437. In their Appendix A, the authors provide a summary 
of mortgage foreclosure procedures and anti-deficiency statutes in 
the 50 states and the District of Columbia. They classify 11 states 
(Alaska, Arizona, California, Iowa, Minnesota, Montana, North 
Carolina (for purchase mortgages only), North Dakota, Oregon, 
Washington and Wisconsin) as non-recourse states.
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    Under the final rules, any excess of indebtedness secured by the 
primary residence over the estimated fair market value of the residence 
is considered a liability for purposes of determining accredited 
investor status on the basis of net worth, whether or not the lender 
can seek repayment from other assets in default. In our view, the full 
amount of the debt incurred by the investor is the most appropriate 
value to use in determining accredited investor status. That is the 
basis on which interest accrues under the mortgage and the amount that 
third parties would look to in assessing creditworthiness. We do not 
believe that the treatment of a mortgage should vary solely because of 
state laws that limit the rights of the lender in an action to enforce 
the borrower's promise to repay. Such laws vary significantly in scope 
and procedural requirements, and their operation is often contingent on 
the specific foreclosure process chosen by the lender and other factors 
beyond the borrower's control.\45\ We believe it would add substantial 
complexity to the rule if market participants were called upon to 
determine how an anti-deficiency statute would operate in the 
individual circumstances of each prospective investor. Moreover, the 
data available to us suggest that there would be no material difference 
in the number of households that qualify as accredited investors if we 
were to allow special treatment of non-recourse mortgages.\46\ 
Accordingly, the final rules specify that debt secured against the 
primary residence in excess of the estimated fair market value of the 
primary residence must be treated as a liability in the net worth 
calculation.
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    \45\ See id.
    \46\ Using data from the 2007 Federal Reserve Board Survey of 
Consumer Finances, staff from our Division of Risk, Strategy and 
Financial Innovation estimate that in 2007 the same number of U.S. 
households (approximately 7.6 million) would have qualified for 
accredited investor status on the basis of net worth under our 
amendments and under an alternative net worth calculation that 
excluded both the fair market value of the primary residence and all 
indebtedness secured by the residence, even indebtedness in excess 
of the fair market value of the residence. Based on discussions with 
staff economists at the Federal Reserve Board, estimates derived 
from their unpublished 2009 supplemental update of the 2007 survey 
are qualitatively similar. For both 2007 and 2009, the data suggest 
that the number of households nationwide that qualify as accredited 
investors is not affected by whether the net worth calculation 
includes or excludes the underwater portion of debt secured by the 
primary residence.
---------------------------------------------------------------------------

(3) Increases in Mortgage Debt in the 60 Days Before Sale of Securities
    We also solicited comment on whether the amendments should contain 
a timing provision to prevent investors from artificially inflating 
their net worth by incurring incremental indebtedness secured by their 
primary residence, thereby effectively converting their home equity--
which is excluded from the net worth calculation under the rules 
adopted today--into cash or other assets that would be included in the 
net worth calculation. As an example, we indicated that the amendments 
could provide that the net worth calculation must be made as of a date 
30, 60, or 90 days before the sale of the securities, as well as at the 
time of sale.
    State securities regulators strongly supported this approach, 
noting that it would make the practice of advising investors to use 
equity in their primary residence to purchase securities less 
attractive, thereby helping to ensure that unregistered securities are 
not sold to investors with limited assets other than their homes, who 
may not be able to fend for themselves without the protections afforded 
by registration.\47\ On the other hand, many commentators opposed 
having special rules for debt secured by a primary residence incurred 
close in time to the sale of securities, asserting that imposing such a 
timing provision would unduly complicate the calculation of net 
worth.\48\ Some were particularly concerned that the date when 
accredited investor status has to be determined may not be known 
sufficiently in advance to permit a full net worth calculation 30, 60, 
or 90 days ahead of time, or that such a requirement would force delays 
in capital raising efforts.\49\ We agree that we should avoid adding 
undue complexity in the process for determination of accredited 
investor status; however, we believe that the rule should address 
potential incentives for individuals to incur debt secured by a primary 
residence for the purpose of inflating their net worth to qualify as 
accredited investors. If the rule does not address that issue, the 
population Congress intended to protect--individuals whose net worth is 
below $1 million unless their home equity is taken into account--may be 
incentivized (or urged by unscrupulous salespeople) to take on debt 
secured by their homes for the purpose of qualifying as accredited 
investors and participating in investments without the protection to 
which they are entitled.
---------------------------------------------------------------------------

    \47\ Comment letter from NASAA. The other supporter of a timing 
provision was the Cornell Securities Law Clinic. See comment letter 
from Cornell (``The Clinic believes that a timing rule should not 
require the `60 day' calculation to be performed on the date 60 days 
before the purchase date; rather, the calculation should occur on 
the intended purchase date, and estimate the investor's net worth as 
it was on the date 60 days before the intended purchase date.'').
    \48\ See letters from ABA, Robert Edgerton, Georg Merkl, REISA 
and S&C.
    \49\ See comment letters from ABA and Robert Edgerton.
---------------------------------------------------------------------------

    We believe we have addressed this concern in a manner that manages 
the complexities noted by commentators that could arise from a 
requirement to calculate net worth far in advance of a possible sale of 
securities or to calculate net worth twice. The final rule provides a 
specific provision addressing the treatment of incremental debt secured 
by the primary residence that is incurred in the 60 days before the 
sale of securities.\50\ As described above, debt secured by the primary 
residence generally will not be included as a

[[Page 81798]]

liability in the net worth calculation under the rule, except to the 
extent it exceeds the estimated value of the primary residence. Under 
the final rule, any increase in the amount of debt secured by a primary 
residence in the 60 days before the time of sale of securities to an 
individual generally will be included as a liability, even if the 
estimated value of the primary residence exceeds the aggregate amount 
of debt secured by such primary residence.\51\ Net worth will be 
calculated only once, at the time of sale of securities (the same time 
as under current rules). The individual's primary residence will be 
excluded from assets and any indebtedness secured by the primary 
residence, up to the estimated value of the primary residence at of 
that time, will be excluded from liabilities, except if there is 
incremental debt secured by the primary residence incurred in the 60 
days before the sale of securities. If any such incremental debt is 
incurred, net worth will be reduced by the amount of the incremental 
debt. In other words, the only additional calculation required by the 
60-day look-back provision is to identify any increase in mortgage debt 
over the 60-day period preceding the purchase of securities.
---------------------------------------------------------------------------

    \50\ See, e.g., New Rule 501(a)(i)(B).
    \51\ The fair market value of the primary residence is 
determined as of the time of sale of securities, even if the 
investor has changed his or her primary residence during the 60-day 
period. The rule provides an exception to the 60-day look-back 
provision for increases in debt secured by a primary residence where 
the debt results from the acquisition of the primary residence. 
Without this exception, an individual who acquires a new primary 
residence in the 60-day period before a sale of securities may have 
to include the full amount of the mortgage incurred in connection 
with the purchase of the primary residence as a liability, while 
excluding the full value of the primary residence, in a net worth 
calculation. The 60-day look-back provision is intended to address 
incremental debt secured against a primary residence that is 
incurred for the purpose of inflating net worth. It is not intended 
to address debt secured by a primary residence that is incurred in 
connection with the acquisition of a primary residence within the 
60-day period.
---------------------------------------------------------------------------

    This approach will make it more difficult for individuals to 
manipulate their net worth as calculated under our rules by borrowing 
against their primary residence shortly before seeking to qualify as an 
accredited investor, to take advantage of any positive equity in the 
primary residence. It should, therefore, significantly reduce the 
incentive for individuals to try to ``game'' the accredited investor 
net worth standard or for salespeople to attempt to induce individuals 
to take on incremental debt secured against their homes to facilitate a 
near-term investment in an offering. The new provision may impose 
additional costs and burdens on investors who increase the indebtedness 
secured by their primary residence shortly before seeking to invest in 
a Rule 506 offering if the proceeds of such refinancing are invested in 
the primary residence or are otherwise disposed of without acquiring an 
asset that is included in the net worth calculation, because in such 
circumstances the amount of such additional borrowing will be treated 
as a liability, but the proceeds will not be treated as an asset. If 
such an increase in liabilities causes an individual not to meet the 
$1,000,000 net worth test, and he or she does not otherwise qualify as 
an accredited investor, the individual may be excluded from investment 
opportunities if issuers are unable or unwilling to permit the 
participation of non-accredited investors. However, our approach should 
not present the same practical difficulties as requiring a full net 
worth calculation as of a date 30, 60, or 90 days before securities are 
sold to an investor, in which all assets and liabilities of the 
investor would have to be taken into account based on their values as 
of the specified date.
    We have included a 60-day look-back period for this purpose because 
we believe a 60-day period is long enough to decrease the likelihood 
that parties will attempt to circumvent the standard by taking on new 
debt and waiting for the look-back period to expire, while minimizing 
the potential burden on investors who increase their mortgage debt for 
other reasons. Both letters that commented favorably on the possible 
requirement to calculate net worth as of a specified date before the 
sale of securities supported a 60-day look-back period.\52\ Another 
alternative to address this practice would have been to provide that 
any debt secured by a primary residence that was incurred after the 
original date of purchase of the primary residence would have to be 
counted as a liability, whether or not the fair market value of the 
primary residence exceeded the value of the total amount of debt 
secured by the primary residence. We believe that such a standard would 
be overly restrictive and not provide for ordinary course changes to 
debt secured by a primary residence, such as refinancing and drawings 
on home equity lines.
---------------------------------------------------------------------------

    \52\ See comment letters from Cornell (suggesting a 60-day 
period) and NASAA (suggesting a 60- or 90-day period).
---------------------------------------------------------------------------

(4) Transition Rules
    We did not propose any rules for transition to the new accredited 
investor net worth standards. In the Proposing Release, we questioned 
whether any transition relief would be necessary or appropriate because 
the new standards became effective upon enactment of the Dodd-Frank Act 
on July 21, 2010. We did, however, solicit comment on whether we should 
adopt provisions to permit investors who ceased to qualify as 
accredited investors as a result of the changes effected by Section 
413(a) to be treated as accredited for purposes of certain subsequent 
or ``follow-on'' investments.
    Commentators generally supported a provision that would allow 
investors in that situation to participate in certain types of follow-
on investments.\53\ Some letters argued that such a provision would be 
appropriate to permit investors to protect their proportionate interest 
in an issuer or to exercise rights associated with an existing 
investment on the basis originally bargained for.\54\ Others argued 
more broadly that investors should be permitted to maintain existing 
investment plans to avoid adverse tax or other consequences.\55\ 
Commentators expressed a concern that issuers may be unwilling or 
unable to provide the information required to be provided to non-
accredited investors under Rule 501(b)(1) of Regulation D,\56\ and may 
simply exclude individuals from participating in securities offerings 
who no longer qualify as accredited investors.\57\
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    \53\ See comment letters from ABA, Robert Edgerton, IAA, IPA, 
Georg Merkl, REISA, S&C, Sutherland Asbill & Brennan 
(``Sutherland'') and Steven J. Thayer. Only one comment letter 
objected to a transition provision, arguing that Congressional 
intent is evident from the fact that Section 413(a) was effective 
immediately upon enactment of the Dodd-Frank Act and that investors 
who no longer qualify as accredited investors under Section 413(a) 
may participate in follow-on offerings as non-accredited investors. 
See letter from Cornell.
    \54\ Comment letters identified rights such as pre-emptive 
rights, rights of first refusal and buy-sell agreements, as well as 
provisions that impose dilution or other adverse consequences on 
investors who do not invest in future rounds of financing.
    \55\ See, e.g., comment letters from REISA (roll over of real 
estate investments) and Sutherland (roll over of private placement 
insurance contracts).
    \56\ 17 CFR 230.501(b)(1).
    \57\ Several letters also argued that issuers would not attempt 
to rely on the broader Section 4(2) exemption because it would 
create unnecessary legal risk related to the offering process. See, 
e.g., comment letters from Sutherland and Steven J. Thayer.
---------------------------------------------------------------------------

    We are not persuaded that grandfathering or other transition 
provisions would be appropriate in all circumstances urged by 
commentators. In cases where securities would be purchased based on an 
investment decision made before enactment of the Dodd-Frank Act (for 
example, a capital call that is not subject to conditions under the 
investor's control, under an

[[Page 81799]]

agreement entered into before enactment of the Dodd-Frank Act), 
accredited investor status would have been determined at the time of 
the investment decision. A subsequent change in the investor's 
accredited status would not be relevant, so special accommodation would 
not be needed. With respect to new investment decisions, some 
situations for which commentators requested special treatment could 
raise significant investor protection concerns. For example, certain 
rights to acquire securities in existence before the enactment of the 
Dodd-Frank Act could involve different issuers than the original 
investment. In such circumstances, an investor may not have been 
sufficiently familiar with, or had an opportunity to conduct diligence 
with respect to, such different issuers at the time the investor met 
the accredited investor net worth standard and received such rights.
    We note also that the change in the accredited investor net worth 
standard took effect in July 2010, upon enactment of Section 413(a) of 
the Dodd-Frank Act. No grandfathering or transition provisions were 
included in Section 413(a), so market participants have been operating 
under the new standard for over a year. In particular, where existing 
rights (for example, under derivative instruments such as options, 
warrants and convertibles) give rise to a continuous offering of the 
underlying securities, because no grandfathering was provided by 
statute, issuers have already had to address any concerns that arose 
upon the change in the accredited investor net worth standard.
    We do believe, however, that limited grandfathering would be 
appropriate in connection with investors' exercise of certain pre-
existing rights to acquire securities. The final rules, therefore, 
contain a provision under which the former accredited investor net 
worth test will apply to purchases of securities in accordance with a 
right to purchase such securities,\58\ so long as (i) The right was 
held by a person on July 20, 2010, the day before the enactment of the 
Dodd-Frank Act; (ii) the person qualified as an accredited investor on 
the basis of net worth at the time the right was acquired; and (iii) 
the person held securities of the same issuer, other than the right, on 
July 20, 2010. For example, if an investor who qualified as accredited 
based on net worth at the time of her original investment owned common 
stock of an issuer on July 20, 2010, and on that date had pre-emptive 
rights to acquire additional common stock of that issuer, then when the 
issuer makes an offering of common stock that triggers the pre-emptive 
rights, the investor's net worth will be calculated as it was before 
enactment of the Dodd-Frank Act. Likewise, if the same investor owned 
Series A preferred stock of an issuer on July 20, 2010 and on that date 
had a right of first offer to purchase any equity securities offered by 
the issuer in a future sale, and the issuer proposed to sell Series B 
preferred stock at a future date, then the investor's net worth will be 
calculated as it was before enactment of the Dodd-Frank Act for 
purposes of exercising the right of first offer to purchase Series B 
preferred stock from the issuer. The provision is limited to persons 
who qualified as accredited investors on the basis of net worth at the 
time the relevant rights were originally acquired, and who held 
securities of the issuer other than the rights on July 20, 2010. We 
believe this approach strikes an appropriate balance between preserving 
investors' ability to exercise previously bargained-for rights, which 
otherwise may have been impaired by the change in accredited investor 
definition, and maintaining the investor protection benefits that 
Section 413(a) seeks to achieve.
---------------------------------------------------------------------------

    \58\ The grandfathering provision 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.
---------------------------------------------------------------------------

(5) Other Issues Considered
    In our Proposing Release, we requested comment on two additional 
issues discussed below, which we determined do not require any change 
in our rules.
    Defining ``Primary Residence.'' We solicited comment on whether we 
should define the term ``primary residence'' for purposes of the rules 
we are amending. Our proposal did not contain a definition, consistent 
with our past policies in this area \59\ and in an attempt to avoid 
unnecessary complexity in a rule that is intended to be straightforward 
in application.
---------------------------------------------------------------------------

    \59\ None of our three other rules that use the term ``primary 
residence'' have a definition of the term. See 17 CFR 240.17a-
3(a)(17)(i)(A), 17 CFR 247.701(d)(1)(A) and 17 CFR 210.2-
01(c)(1)(ii)(A)(4). Regulation D also did not define the similar 
term ``principal residence,'' as used in Rule 501(e)(1)(i) of 
Regulation D. 17 CFR 230.501(e)(1)(i). Until now, Regulation D used 
the term ``principal residence'' to exclude any purchasers who are 
relatives or spouses of the purchaser and who share the same 
principal residence as the purchaser for purposes of calculating the 
number of purchasers in a Regulation D offering. As explained below, 
we are adopting amendments to change this reference from ``principal 
residence'' to ``primary residence'' so that it conforms to the 
terminology of the Dodd-Frank Act. See text accompanying note 66 
below.
---------------------------------------------------------------------------

    Several comment letters agreed with us that the term ``primary 
residence'' is well understood, and does not require a legal 
definition.\60\ Two comment letters advocated adoption of a legal 
definition, but did not agree on what definition should apply.\61\
---------------------------------------------------------------------------

    \60\ See, e.g., comment letters from ABA, S&C and Steven J. 
Thayer.
    \61\ See comment letter from Cornell (suggesting the definition 
in Internal Revenue Code Sec.  121). A comment letter from an 
individual suggested that the Commission use the definition of the 
term ``primary residence'' of the Organization for Economic 
Cooperation and Development, at least for non-U.S. investors. See 
letter from Georg Merkl.
---------------------------------------------------------------------------

    We believe that ``primary residence'' has a commonly understood 
meaning as the home where a person lives most of the time. Consistent 
with the approach in Regulation D to reduce unnecessary complexity, we 
are not adopting a definition of the term ``primary residence.''
    Proceeds of Debt Secured by Primary Residence Incurred to Invest in 
Securities. We solicited comment on whether the accredited investor 
definition should contain special provisions addressing the treatment 
of debt secured by a primary residence where the proceeds of the debt 
are used to invest in securities. Under the rules we are adopting 
today, debt secured by the primary residence will generally be excluded 
from the calculation of net worth to the extent of the estimated fair 
market value of the primary residence. NASAA had urged in an advance 
comment letter that netting of such debt not be permitted if proceeds 
of the debt were used to invest in securities. NASAA's concern was 
that, without such a rule, we would create an incentive for 
unscrupulous salespeople to induce investors with significant equity in 
their home to borrow against their home for the purpose of investing in 
unsuitable unregistered offerings.\62\
---------------------------------------------------------------------------

    \62\ Advance comment letter from NASAA.
---------------------------------------------------------------------------

    NASAA made this suggestion again in its comment letter on the 
Proposing Release, which was the only comment letter supporting this 
idea.\63\ The other comment letters that addressed this issue opposed 
it.\64\ Critics asserted that such a change would add substantial 
complexity to the compliance process because of the difficulties of 
tracing loan proceeds, and suggested that the concerns articulated by 
NASAA could be better and more effectively addressed through 
enforcement of existing Securities Act and broker-dealer rules.

[[Page 81800]]

After reviewing all the comment letters and further considering the 
issue, we have included the 60-day look-back provision discussed in 
Part II.A.3 above rather than a tracing provision. We believe that 
requiring incremental debt secured by the primary residence to be 
treated as a liability in the net worth calculation for 60 days after 
it is incurred will be a substantial disincentive to inappropriate 
sales practices, and will be much simpler and more certain in 
application than a tracing rule.\65\
---------------------------------------------------------------------------

    \63\ See letter from NASAA.
    \64\ See, e.g., letters from ABA, REISA, S&C, Robert G. 
Edgerton, Georg Merkl and Steven J. Thayer.
    \65\ The standards governing broker-dealer sales practices will 
also apply in relation to the activities of broker-dealer personnel. 
NASD (now known as FINRA) Rule 2310 requires registered 
representatives of broker-dealers to make only suitable 
recommendations to their customers. See Financial Industry 
Regulatory Authority, NASD Rule 2310: Recommendations to Customers 
(Suitability) (2010) (available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3638). Depending on 
the facts and circumstances, such behavior may also rise to the 
level of fraud under Section 17(a) of the Securities Act, 15 U.S.C. 
77q(a), or Section 10(b) of the Securities Exchange Act, 15 U.S.C. 
78j(b), or the Commission's antifraud rules issued under those 
statutory provisions.
---------------------------------------------------------------------------

B. Technical and Conforming Amendments

    As proposed, we are changing the reference to ``principal 
residence'' currently in Rule 501(e)(1)(i) of Regulation D \66\ to 
``primary residence,'' to conform it to the new language in Rule 501. 
We received one letter supporting this change,\67\ and no letters 
objecting to this change.
---------------------------------------------------------------------------

    \66\ For purposes of calculating the number of purchasers in a 
Regulation D offering, Rule 501(e)(1)(i) uses the term ``principal 
residence'' to exclude any purchasers who are relatives or spouses 
of a purchaser of a Regulation D security and who share the same 
``principal residence'' as the purchaser of the security. 17 CFR 
230.501(e)(1)(i).
    \67\ See letter from ABA.
---------------------------------------------------------------------------

    Also as proposed, we are amending the references to former 
Securities Act Section 4(6) in Form D and several of our rules to refer 
to Section 4(5), as former Section 4(6) was renumbered by Section 
944(a)(2) of the Dodd-Frank Act. Specifically, we are amending Rule 
144(a)(3)(viii) (definition of ``restricted securities'') and Rule 
155(a) (integration of abandoned offerings) of the general Securities 
Act rules; Rule 500(a)(1) of the Securities Act form rules; Item 6 and 
the General Instructions to Form D under the Securities Act; Rule 17j-
1(a)(8) (personal investment activities of investment company 
personnel) under the Investment Company Act, and Rule 204A-1(e)(7) 
(investment adviser codes of ethics) under the Investment Advisers Act.
    We are also removing the authority citation preceding the 
Preliminary Notes to Regulation D.

III. Paperwork Reduction Act

    The amendments we are adopting do not contain a ``collection of 
information'' requirement within the meaning of the Paperwork Reduction 
Act of 1995.\68\ Accordingly, the Paperwork Reduction Act is not 
applicable.
---------------------------------------------------------------------------

    \68\ 44 U.S.C. 3501-3521.
---------------------------------------------------------------------------

IV. Cost-Benefit Analysis

A. Background and Summary of Proposals

    As discussed above, we are adopting amendments to the accredited 
investor standards in our rules under the Securities Act to implement 
the requirements of Section 413(a) of the Dodd-Frank Act.
    Section 413(a) of the Dodd-Frank Act requires the definitions of 
``accredited investor'' in the Securities Act rules to exclude the 
value of a person's primary residence for purposes of determining 
whether the person qualifies as an ``accredited investor'' on the basis 
of having a net worth in excess of $1 million. Under the previous 
standard, individuals qualified as accredited investors if they had a 
net worth of more than $1 million, including the value of their primary 
residence. The substantive change to the net worth standard was 
effected by operation of the Dodd-Frank Act upon enactment; however, 
Section 413(a) also requires us to adjust the accredited investor 
definitions in our Securities Act rules to conform to the new standard. 
We are therefore adopting conforming amendments to Securities Act Rule 
501(a)(5) of Regulation D and Securities Act Rule 215(e).
    This analysis focuses on the costs and benefits to the economy of 
including the specific amendments described below, rather than on the 
costs and benefits of the new accredited investor net worth standard 
itself. The new standard was mandated by Congress in Section 413(a) of 
the Dodd-Frank Act and does not reflect the exercise of our rulemaking 
discretion.
    The language we are adopting reflects our exercise of discretion in 
choosing a method to implement the statutory language set forth in 
Section 413(a) (namely, that net worth for purposes of accredited 
investor qualification should be calculated excluding the positive 
equity, if any, in the primary residence) over two other possible 
methods to implement the statutory language. As explained in our 
Proposing Release, these two other methods of implementation of the 
Section 413(a) language are: (1) excluding from net worth the fair 
market value of the primary residence, but including all indebtedness 
secured by the primary residence; and (2) excluding from net worth the 
fair market value of the primary residence and all indebtedness secured 
by the primary residence, even if it exceeds the fair market value of 
the primary residence. We also exercised our discretion in requiring 
that incremental debt secured by the primary residence that is incurred 
in the 60 days before the accredited investor determination is made 
(other than debt incurred in connection with the acquisition of a 
primary residence) must be treated as a liability in the net worth 
calculation (i.e., may not be netted against the value of the 
residence, even if the value of the residence exceeds the amount of 
debt secured against it), and in adding a limited grandfathering 
provision under which, in certain circumstances, the former accredited 
investor net worth standard will apply in connection with acquisitions 
of securities pursuant to rights held by a person before enactment of 
the Dodd-Frank Act.

B. Comments on the Cost-Benefit Analysis

    In the Proposing Release, we requested qualitative and quantitative 
feedback on the nature of the benefits and costs described and any 
benefits and costs we may have overlooked. No comment letters expressly 
addressed the cost-benefit analysis in the Proposing Release, but some 
comment letters cited certain costs and benefits consistent with those 
described in this release in the course of making a variety of 
suggestions and observations. For example, the rules that we are 
adopting, which may result in individuals' having to estimate the value 
of their primary residence in order to determine whether the amount of 
debt secured against the residence exceeds the estimated fair market 
value of the residence, was criticized by some commentators on the 
basis that it would increase compliance costs.\69\ As indicated above, 
individuals were required to estimate the value of their primary 
residence to calculate net worth as defined before enactment of the 
Dodd-Frank Act, and the Commission is not aware that this caused a 
problem for individuals seeking to qualify as accredited investors on 
that basis. Others asserted that the failure to include grandfathering 
or other transition

[[Page 81801]]

provisions in the new rules would impose costs on investors (who may be 
unable to protect their existing investments from dilution or to 
exercise pre-existing rights) and on issuers (which may have a harder 
time raising capital).\70\ We have attempted to respond to that comment 
by providing for limited grandfathering.
---------------------------------------------------------------------------

    \69\ See letters from IPA, Georg Merkl.
    \70\ See e.g., letters from ABA, Investment Advisers 
Association, Investment Program Association, Real Estate Investment 
Securities Association, S&C, Sutherland Asbill & Brennan and Steven 
J. Thayer.
---------------------------------------------------------------------------

C. Benefits

    We believe the rules we are adopting provide the most appropriate 
method to implement Section 413(a), and will result in the following 
benefits compared to other possible methods to implement Section 
413(a):
     We believe the final amendments most accurately reflect 
the manner in which individual net worth has traditionally been 
determined and understood, and what is commonly understood by ``the 
value of a person's primary residence.'' We believe investors and 
issuers will benefit from implementing rules that are easy to 
understand and consistent with conventional net worth calculation 
concepts through reduced transaction costs relative to other 
alternatives.\71\
---------------------------------------------------------------------------

    \71\ See notes 35-36 above and accompanying text.
---------------------------------------------------------------------------

     The amendments will result in a larger pool of accredited 
investors than the first alternative method of implementation, under 
which all indebtedness secured by the primary residence would be 
included as a liability in the net worth calculation. The available 
data suggest that there is no material difference in the size of the 
accredited investor pool between the alternative we are adopting and 
the second alternative method, under which all indebtedness secured by 
the primary residence would be excluded from the net worth calculation, 
even if in excess of the estimated value of the primary residence.\72\ 
To the extent that exempt offerings to accredited investors are less 
costly for issuers to complete than registered offerings, a larger pool 
of accredited investors that may participate in these offerings could 
result in cost savings for issuers conducting these offerings.
---------------------------------------------------------------------------

    \72\ Using data from the 2007 Federal Reserve Board Survey of 
Consumer Finances, our Division of Risk, Strategy and Financial 
Innovation estimates that in 2007 approximately 8.3 million 
households (7.2% of U.S. households) would have qualified as 
accredited under the standards in our new rules on the basis of net 
worth, annual income or both. Approximately 7.6 million of such 
households (6.5% of U.S. households) would have qualified on the 
basis of net worth. If we adopted a standard based on an alternative 
method of implementation of Section 413(a) that excludes from the 
net worth calculation the fair market value of the primary residence 
but not any indebtedness secured by the primary residence, only 7.8 
million households (6.7%) would have qualified as accredited. 
Conversely, if we adopted a standard under which both the fair 
market value of the primary residence and all indebtedness secured 
by the primary residence, even indebtedness in excess of the fair 
market value of the primary residence, were excluded from the net 
worth calculation, the number of accredited U.S. households would 
have been the same as under the approach we are adopting. More 
information regarding the survey may be obtained at http://www.federalreserve.gov/pubs/oss/oss2/scfindex.html. See also note 46 
above and accompanying text. Staff at the Federal Reserve also 
informed us that based on an unpublished 2009 supplemental Survey of 
Consumer Finances, which surveyed the same households that were 
surveyed in 2007, estimates of the number of qualifying households 
in 2009 under the various methods of implementation of Section 
413(a) are qualitatively similar to estimates derived from the 2007 
survey. For both 2007 and 2009, the data suggest that the number of 
households nationwide that qualify as accredited investors is not 
affected by whether the net worth calculation includes or excludes 
the underwater portion of debt secured by the primary residence.
---------------------------------------------------------------------------

     The additional provision in the final rules that requires 
incremental debt secured against the primary residence to be treated as 
a liability in the net worth calculation for 60 days after it is 
incurred will eliminate individuals' ability to inflate their net worth 
for purposes of the accredited investor definition by taking on 
incremental debt secured against their primary residence shortly before 
securities are sold to them. The look-back period will reduce 
incentives to manipulate net worth calculations, should make investors 
whose net worth reaches the accredited investor threshold only if value 
of available home equity is included as part of a net worth calculation 
less susceptible to high-pressure sales tactics, and generally will 
provide investor protection benefits to households which, under the 
criteria of Section 413(a), are less able to bear the economic risk of 
an investment in unregistered securities.
     The provision in the final rules will apply the pre-Dodd-
Frank Act accredited investor net worth test to acquisitions of 
securities pursuant to rights held on July 20, 2010 by persons who 
qualified as accredited investor on the basis of net worth at the time 
the rights were acquired and who held securities of the issuer other 
than the rights on July 20, 2010. Under this provision, investors who 
no longer qualify as accredited investors under the new net worth 
standard, but who would qualify under the former standard, will qualify 
as accredited investors in that limited context. This should provide a 
benefit to both investors and issuers, in that investors who have 
ceased to qualify as accredited investors because of the change in net 
worth standard will be able to exercise pre-existing rights even if the 
issuer is unable or unwilling to permit exercise by non-accredited 
investors, and at lower cost than if the individuals did not qualify as 
accredited investors.

D. Costs

    Like our analysis of the benefits, our analysis of the costs 
focuses on the costs attributable to our adopted language on how to 
treat the primary residence and debt secured by the primary residence 
in the calculation of net worth, including the treatment of debt 
incurred in the 60 days before the net worth calculation is performed, 
and on the costs attributable to the transition provision included in 
the final rules.
    Many of the potential costs of our amendments are dependent on a 
number of factors. Costs may include the following:
     Our amendments involve more complex calculations than the 
two alternative possible approaches we have identified.\73\ Although no 
third party appraisal is required, our amendments may require 
estimating the fair market value of the investor's primary residence to 
determine whether it exceeds the amount of indebtedness secured by the 
primary residence. In contrast, both of the alternative net worth 
calculations could be performed merely by ignoring the primary 
residence as an asset in determining the net worth amount, and in the 
case of the second alternative method of implementation also ignoring 
the indebtedness secured by the primary residence. However, this would 
appear to be a manageable cost. Investors had to estimate the fair 
market of their primary residence to calculate net worth under the net 
worth standard for accredited investor that applied before enactment of 
the Dodd-Frank Act, and the Commission is not aware that market 
participants found the need for such an estimate to be problematic.
---------------------------------------------------------------------------

    \73\ Some commentators objected to the proposal on this basis. 
See note 39 and accompanying text.
---------------------------------------------------------------------------

     Where indebtedness secured by the primary residence has 
increased in the 60 days preceding the net worth calculation, other 
than in connection with the acquisition of the primary residence, our 
amendments will also require determining the amount of that increase, 
and treating that amount as a liability in the net worth calculation.
     The amendments could encourage investors (or incentivize 
salespeople to encourage investors) to take on indebtedness secured by 
their primary

[[Page 81802]]

residence with the primary motive of inflating their net worth in order 
to satisfy the new accredited investor net worth standard. As noted 
above, we believe the requirement to treat as a liability any 
incremental debt secured by the primary residence that is incurred in 
the 60 days before the accredited investor determination will reduce 
this incentive by requiring 60 days to pass before assets obtained with 
the proceeds of incremental indebtedness secured by the primary 
residence could result in an increase in net worth under the rule.
     Our amendments require that an investor's net worth 
calculation include as a liability any amount by which the indebtedness 
secured by the investor's primary residence exceeds the estimated fair 
market value of the residence. It is possible that our amendments will 
result in a smaller pool of eligible accredited investors than if we 
implemented an alternative approach that would exclude all indebtedness 
secured by the primary residence, even amounts in excess of the value 
of the residence. The data available to us do not support this view. 
The 2007 Federal Reserve Board Survey of Consumer Finances suggests 
that there is no difference in the number of households that would have 
qualified under the two standards in 2007 (that is, subject to sampling 
error, there were no households that had a net worth of $1 million or 
less if the underwater portion of the mortgage was considered as a 
liability but greater than $1 million if it was disregarded).\74\ Staff 
at the Federal Reserve have informed us that based on an unpublished 
2009 supplemental Survey of Consumer Finances, estimates of the number 
of qualifying households in 2009 under the two methods of 
implementation are qualitatively similar to estimates derived from the 
2007 survey. Nevertheless, if our amendments result in a smaller pool 
of accredited investors than would otherwise be the case, that could 
result in increased costs for companies and funds that are seeking 
accredited investors to participate in their exempt offerings.
---------------------------------------------------------------------------

    \74\ See note 46 above.
---------------------------------------------------------------------------

     The treatment of indebtedness secured by the primary 
residence that is incurred within 60 days before the accredited 
investor determination may result in some individuals failing to meet 
the $1 million net worth threshold for 60 days after entering into new 
financing or refinancing arrangements, who would have met such 
threshold if no look-back provision applied, if the proceeds of such 
refinancing are invested in the primary residence or are otherwise 
disposed of without acquiring an asset that is included in the net 
worth calculation. Such individuals may lose investment opportunities 
if issuers are not willing or able to allow them to participate in 
offerings conducted during the period in which they do not qualify as 
accredited investors.
     The transition provision we are including will, in limited 
circumstances, permit investors who do not qualify as accredited 
investors under the new net worth standard, but who do qualify under 
the previous standard, to acquire securities pursuant to pre-existing 
rights without the protections afforded to non-accredited investors. 
This will impose costs to the extent that such investors would have 
benefited from such protections. The transition provision applies only 
in limited circumstances, which may prevent some investors from 
participating in some offerings and may cause issuers to incur the cost 
of seeking out other investors.

V. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition and Capital Formation

    Section 2(b) of the Securities Act requires us, when engaging in 
rulemaking where we are required to consider or determine whether an 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation. In the 
Proposing Release, we considered our proposed amendments and requested 
comment on their potential impact in light of those standards. We 
believe the amendments adopted today may facilitate capital formation 
and promote efficiency, relative to an alternative method of 
implementation that would exclude only the fair market value of the 
primary residence from the net worth calculation and would not provide 
grandfathering to facilitate exercise of pre-existing rights under 
certain circumstances. We do not anticipate that the amendments will 
have any effects on competition.
    We believe the amendments impose no significant burden on 
efficiency, competition and capital formation beyond any that may have 
been imposed by enactment of the Dodd-Frank Act. As discussed in the 
cost-benefit analysis in Part IV above, however, the language of 
Section 413(a) could be subject to alternative methods of 
implementation if our rules do not provide standards for how to 
calculate the value of the primary residence. In this regard, we added 
explanatory language to our rules on how to treat the primary residence 
and indebtedness secured by the primary residence in determining 
whether a person qualifies under the accredited investor net worth 
standard. We believe these amendments further the purposes underlying 
the requirements of Section 413(a) of the Dodd-Frank Act.
    The adopted explanatory language requires that in calculating net 
worth:
     The primary residence not be included as an asset; and
     Debt secured by the primary residence not be included as a 
liability, except that
     If the amount of debt secured by the primary residence has 
increased in the 60 days preceding the accredited investor 
determination, other than in connection with the acquisition of the 
residence, the amount of such increase must be included as a liability; 
and
     If the amount of debt secured by the primary residence 
exceeds the estimated fair market value of the primary residence, the 
amount of such excess must be included as a liability.
    As described above, we believe the approach we are adopting is 
generally consistent with what is commonly understood by ``the value of 
a person's primary residence,'' and is preferable to either of the two 
alternative approaches. The addition of provisions related to any net 
increase in the amount of debt secured by the primary residence in the 
60 days preceding a sale of securities is a straightforward provision 
to safeguard against manipulation of the general rule. Several comment 
letters addressed the burden and uncertainty on investors and issuers 
inherent in an approach that relies on a determination of the fair 
market value of the primary residence, which is necessary in order to 
determine whether any indebtedness secured by the primary residence 
exceeds the value of the residence.\75\ These letters favored an 
approach that excludes from the net worth calculation both the value of 
the primary residence and all indebtedness secured by the primary 
residence, which they argue would provide investors and their advisors 
with certainty regarding the net worth calculation. We believe, 
however, that it would be inappropriate to implement Section 413(a) in 
this way, because it would result in a higher net worth for investors 
with ``underwater'' mortgages as compared to the same investors' basic 
net worth calculated without excluding the value of the

[[Page 81803]]

primary residence.\76\ Furthermore, we note that, before the enactment 
of the Dodd-Frank Act, a net worth calculation in connection with 
determining accredited investor status required estimating the fair 
market value of the primary residence. The existing pool of accredited 
investors and issuers should be familiar with this kind of estimate, 
which should mitigate the burdens cited in these letters.
---------------------------------------------------------------------------

    \75\ See letters from IPA, Georg Merkl, REISA and Steven J. 
Thayer.
    \76\ See note 42 above and accompanying text.
---------------------------------------------------------------------------

    The final amendments may result in a pool of accredited investors 
that is larger than the first alternative approach, which would not net 
out debt secured by the primary residence.\77\ To the extent that 
exempt offerings to accredited investors are less costly for issuers to 
complete compared to registered offerings, issuers conducting these 
exempt offerings under the new amendments could potentially experience 
greater cost savings than under the first alternative standard. Based 
on the available data, the second alternative approach to excluding the 
value of the primary residence under Section 413(a) (excluding from net 
worth the fair market value of the primary residence and all 
indebtedness secured by the primary residence, including all such 
indebtedness in excess of the fair market value of the property) would 
not result in a measurably larger pool of eligible accredited investors 
than under our amendments, and therefore would not appear to result in 
additional cost savings compared to our amendments.\78\
---------------------------------------------------------------------------

    \77\ See note 72 above and accompanying text.
    \78\ See note 46 above and accompanying text.
---------------------------------------------------------------------------

    We believe that the provisions in the final rules dealing with the 
treatment of debt secured by the primary residence will not 
significantly affect the costs of compliance for most market 
participants, and therefore will not have a significant effect on 
efficiency or capital formation. Where the estimated fair market value 
of the primary residence may be less than the amount of debt secured by 
the residence, individuals will have to estimate such fair market value 
in order to establish whether any portion of the debt secured by the 
primary residence must be included as a liability in the net worth 
calculation. The rules require an estimated fair market value only; no 
third party valuation will be required.
    There is some further complexity to the net worth calculation for 
individuals who have increased the amount of debt secured by their 
primary residence in the 60 days before seeking to qualify as 
accredited investors, in that they will be required to treat the 
incremental debt as a liability. This provision may also result in some 
individuals' ceasing to satisfy the $1 million net worth threshold for 
60 days after entering into new financing arrangements that increase 
the amount of indebtedness secured by their primary residence, if the 
proceeds of such financing are invested in the primary residence or are 
otherwise disposed of without creating an asset for net worth purposes. 
This may result in the individuals' losing investment opportunities, 
and issuers' losing qualified investors during such 60-day period.
    Several commentators expressed concern that not providing 
grandfathering could impose costs on both investors and issuers, 
including increased transaction costs for offerings that no longer 
qualify for exemption or that include non-accredited investors; \79\ 
dilution or other impairment of existing investments for investors that 
are excluded from follow-on investment opportunities because they no 
longer qualify as accredited; \80\ investors being forced to abandon 
investment strategies; \81\ investors losing the benefit of previously 
bargained-for rights; \82\ burdens on issuers because existing 
investors may be ineligible to make follow-on investments; \83\ and the 
impact on private company capital formation attributable to a decrease 
in the number of accredited investors and the withdrawal of broker-
dealers from the private placement market.\84\
---------------------------------------------------------------------------

    \79\ Georg Merkl; REISA.
    \80\ Georg Merkl; S&C Sutherland; ABA; IPA; REISA; IAA; Steven 
J. Thayer.
    \81\ Sutherland; IAA.
    \82\ Robert G. Edgerton; S&C IAA; Steven J. Thayer.
    \83\ IPA; REISA; IAA.
    \84\ REISA.
---------------------------------------------------------------------------

    While the Commission acknowledges these potential costs, there are 
no available data tracking Regulation D investment by household, so we 
cannot develop quantitative estimates of the economic impact of 
eliminating from the pool of accredited investors the households that 
no longer qualify based on the new net worth standard, or of providing 
exemptive or other relief from the new standard, which would keep such 
households in the accredited investor pool. This impact arises 
principally as a result of the enactment of Section 413(a) of the Dodd-
Frank Act and only to a limited extent from our exercise of rulemaking 
discretion.
    The final rules provide for limited transition relief by applying 
the former accredited investor net worth test to acquisitions of 
securities pursuant to rights to acquire securities, if the rights were 
held on July 20, 2010, the person qualified as an accredited investor 
on the basis of net worth at the time the rights were acquired, and the 
person held securities of the issuer other than the rights on July 20, 
2010. We believe this provision strikes an appropriate balance between 
preserving investors' ability to exercise previously bargained-for 
rights, which otherwise may have been impaired by the change in the 
accredited investor definition, and maintaining the investor protection 
benefits that Section 413(a) seeks to achieve.
    Where the transition provision is unavailable, the new accredited 
investor net worth test will apply. This may prevent some investors 
from participating in some offerings and cause issuers to seek out 
other investors. However, we believe the final rules will provide 
benefits for individuals who would meet the $1 million accredited 
investor net worth standard only if their home equity were taken into 
account, to the extent they are protected by the enhanced disclosures 
required in registered offerings and offerings involving non-accredited 
investors, or become ineligible to participate in investments in 
restricted securities pursuant to Regulation D or Section 4(5), which 
are generally substantially less liquid than securities issued in 
registered offerings and may entail substantial additional risks.
    We do not believe the amendments affect competition beyond what is 
required by Section 413(a). The amendments would apply equally to all 
issuers participating in exempt offerings under Regulation D and 
Section 4(5), in respect of all of their investors. We also do not 
believe that Section 413(a) itself places a burden on competition that 
our rules should ameliorate, except to the extent provided by the 
transition provision.
    In addition to the effects described above, the amendments may 
positively affect efficiency and capital formation in other ways by 
providing a clear standard to calculate and exclude the value of the 
primary residence. This should generally benefit issuers and investors 
by making the requirements of Section 413(a) easier to apply and comply 
with, reducing the risk of sales to investors who do not meet the new 
accredited investor net worth standards, as well as the risk that an 
issuer may violate Securities Act registration requirements. Clear 
rules will also serve to promote efficiency by reducing the risk of 
issuers' inability to raise capital because of uncertainty in 
interpreting our rules. Greater clarity and certainty in our accredited 
investor net worth standards also should foster greater

[[Page 81804]]

confidence in our private placement markets and ultimately reduce the 
cost of capital, promoting increased capital formation, especially 
small business capital formation, which Regulation D was originally 
designed to promote.

VI. Final Regulatory Flexibility Act Analysis

    This final regulatory flexibility analysis has been prepared in 
accordance with the Regulatory Flexibility Act.\85\ This final 
regulatory flexibility analysis relates to amendments to our accredited 
investor rules under the Securities Act to implement the requirements 
of Section 413(a) of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \85\ 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------

A. Reasons for and Objectives of the Amendments

    The reason for the amendments is to implement the requirements of 
the Dodd-Frank Act, primarily the requirements of Section 413(a) of 
that statute. Section 413(a) requires the definitions of ``accredited 
investor'' in the Securities Act rules to exclude the value of a 
person's primary residence for purposes of determining whether the 
person qualifies as an ``accredited investor'' on the basis of having a 
net worth in excess of $1 million. Under the previous standard, 
individuals qualified as accredited investors if they had a net worth 
of more than $1 million, including the value of their primary 
residence. The change to the net worth standard was effective upon 
enactment by operation of the Dodd-Frank Act; but Section 413(a) also 
requires us to revise the Securities Act accredited investor 
definitions to conform to the new standard, which we are doing by 
revising Securities Act Rule 501(a)(5) of Regulation D and Rule 215(e).
    Our primary objective is to implement the requirements for a new 
accredited investor net worth standard in Section 413(a) of the Dodd-
Frank Act. We note that Section 413(a) does not prescribe the method 
for calculating the value of the primary residence, nor does it address 
specifically the treatment of indebtedness secured by the residence for 
purposes of the net worth determination. Accordingly, we are exercising 
our discretion by providing explicit requirements regarding the 
treatment of the primary residence and indebtedness secured by the 
primary residence in the calculation of net worth. We believe this 
standard is generally consistent with conventional and commonly 
understood methods of determining net worth, and what is commonly 
understood by ``the value of a person's primary residence'' (with the 
addition of a provision for the special treatment of debt secured by a 
primary residence that is incurred in the 60 days preceding a sale of 
securities), and is preferable to other possible methods of 
implementation of the statutory language, such as: (1) Excluding from 
net worth the fair market value of the primary residence without 
netting out indebtedness secured by the primary residence; and (2) 
excluding from net worth the fair market value of the primary residence 
and all indebtedness secured by the primary residence, regardless of 
whether it exceeds the fair market value of the primary residence.
    We are describing how to treat the primary residence and 
indebtedness secured by the primary residence in the calculation of net 
worth, so that implementation proceeds efficiently, with a minimum 
amount of uncertainty. We believe these amendments will help to reduce 
the cost of exempt offerings under Regulation D and Section 4(5), 
relative to the cost of such transactions with less specific 
implementation of Section 413(a), by reducing uncertainty among issuers 
and investors in applying the new accredited investor net worth 
standard mandated by Section 413(a) of the Dodd-Frank Act. By providing 
greater specificity, we are attempting to remove a possible impediment 
to issuers using these forms of offering, thereby potentially lowering 
the cost of capital generally and facilitating capital formation, 
especially for smaller issuers, while protecting investors.
    The final amendments also address incremental indebtedness secured 
by the primary residence that is incurred within 60 days before the 
relevant sale of securities. This provision will eliminate individuals' 
ability to artificially inflate their net worth for purposes of the 
accredited investor definition by taking on incremental debt secured 
against their residence shortly before participating in an exempt 
offering.
    The final amendments also include a transition provision, under 
which the former accredited investor net worth test will apply to 
acquisitions of securities pursuant to rights to acquire securities, if 
the rights were held on July 20, 2010, the person qualified as an 
accredited investor on the basis of net worth at the time the rights 
were acquired, and the person held securities of the issuer other than 
the rights on July 20, 2010. This provision should facilitate the 
exercise of rights held at the time of enactment of the Dodd-Frank Act 
by persons who would qualify as accredited investors under the former 
test but not the new test in limited circumstances that should not give 
rise to significant investor protection concerns.

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comment on every aspect of 
the initial regulatory flexibility analysis (``IRFA''), including the 
number of small entities that would be affected by the proposed 
amendments, the nature of the impact, how to quantify the number of 
small entities that would be affected, and how to quantify the impact 
of the proposed amendments. We did not receive comments specifically 
addressing the IRFA.

C. Small Entities Subject to the Rule

    The amendments will affect issuers that are small entities, because 
issuers that are small entities must believe or have a reasonable basis 
to believe that prospective investors are accredited investors at the 
time of the sale of securities if they are relying on the definition of 
``accredited investor'' for an exemption under Regulation D or Section 
4(5). For purposes of the Regulatory Flexibility Act under our rules, 
an issuer is a ``small business'' or ``small organization'' if it has 
total assets of $5 million or less as of the end of its most recent 
fiscal year.\86\ For purposes of the Regulatory Flexibility Act, an 
investment company is a small entity if it, together with other 
investment companies in the same group of related investment companies, 
has net assets of $50 million or less as of the end of its most recent 
fiscal year. The amendments apply to all issuers that rely on the 
accredited investor net worth standards in the exemptions to Securities 
Act registration in Regulation D and Section 4(5).
---------------------------------------------------------------------------

    \86\ 17 CFR 230.157.
---------------------------------------------------------------------------

    All issuers that sell securities in reliance on Regulation D and 
Section 4(5) must file a notice on Form D with the Commission. However, 
the vast majority of companies and funds filing notices on Form D are 
not required to provide financial reports to the Commission. For the 
fiscal year ended September 30, 2010, 22,941 issuers filed a notice on 
Form D. We believe that many of these issuers are small entities, but 
we currently do not collect information on total assets of all issuers 
to determine if they are small entities for purposes of this analysis. 
We note, however, that for the fiscal year ended September 30, 2010, 
the median offering size for offerings under Regulation D was 
approximately $1 million, which is

[[Page 81805]]

consistent with the prevalence of small issuers.

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

    None of our amendments will increase the information or time 
required to complete the Form D that must be filed with the Commission 
in connection with sales under Regulation D and Section 4(5). Our 
amendments adjust our rules so they comply with the requirements of 
Section 413(a) of the Dodd-Frank Act, including adding an anti-evasion 
provision with respect to debt secured by a primary residence incurred 
within the 60 days before a sale of securities and a limited transition 
provision. The rules would not require any further disclosure than is 
currently required in offerings made in reliance on Regulation D and 
Section 4(5). To the extent that the amendments provide standards on 
how to treat the primary residence and indebtedness secured by the 
primary residence in calculating net worth under the accredited 
investor definition, we believe that they will eliminate potential 
ambiguity and facilitate compliance with the accredited investor net 
worth standard mandated by the Dodd-Frank Act.

E. Agency Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish the stated objective of our 
amendments, while minimizing any significant adverse impact on small 
entities. In connection with the amendments, we considered the 
following alternatives:
     The establishment of different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities;
     The clarification, consolidation, or simplification of the 
rule's compliance and reporting requirements for small entities;
     The use of performance rather than design standards; and
     An exemption from coverage of the amendments, or any part 
thereof, for small entities.
    With respect to the establishment of special compliance 
requirements or timetables under our amendments for small entities, we 
do not think this is feasible or appropriate. Our amendments do not 
establish any compliance requirements or timetables for compliance that 
we could adjust to take into account the resources available to small 
entities. Moreover, the amendments are designed to eliminate 
uncertainty among issuers and investors that may otherwise result from 
inserting only the bare operative language from Section 413(a) of the 
Dodd-Frank Act in our rules. Providing greater specificity in our rules 
should provide issuers, including small entities, and investors with 
greater certainty concerning the availability of the Regulation D and 
Section 4(5) exemptions to Securities Act registration that rely on the 
accredited investor definition. This should facilitate efficient access 
to capital for both large and small entities consistent with investor 
protection.
    Likewise, with respect to potentially clarifying, consolidating, or 
simplifying compliance and reporting requirements, the amendments do 
not impose any new compliance or reporting requirements or change any 
existing requirements.
    With respect to using performance rather than design standards, we 
do not believe doing so in this context would be consistent with our 
objective or with the statutory requirement. Our amendments seek to 
specify how issuers should calculate the value of a person's primary 
residence for purposes of excluding its value in determining whether 
the person qualifies as an accredited investor on the basis of net 
worth. Specifying that issuers should calculate net worth by excluding 
the value of the primary residence and leaving the method of 
calculation to the discretion of the issuer, as a performance standard 
would, frustrates our purpose and denies small entities and others of 
the benefits of certainty that the amendments are designed to provide.
    With respect to exempting small entities from coverage of these 
amendments, we believe such a provision would have no impact on the 
regulatory burdens on small entities, since Section 413(a) became 
effective upon enactment. Our amendments are designed to provide for 
the protection of investors without unduly burdening both issuers and 
investors, including small entities and their investors. They also are 
designed to minimize confusion among issuers and investors. Exempting 
small entities could potentially increase their regulatory burdens and 
increase confusion. We have endeavored to minimize the regulatory 
burden on all issuers, including small entities, while meeting our 
regulatory objectives.

VIII. Statutory Authority and Text of the Amendments

    The amendments described in this release are being adopted under 
the authority set forth in Sections 2(a)(15), 3(b), 4(2), 19 and 28 of 
the Securities Act, as amended,\87\ Section 38(a) of the Investment 
Company Act,\88\ Section 211(a) of the Investment Advisers Act \89\ and 
Sections 413(a) and 944(a) of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \87\ 15 U.S.C. 77b(a)(15), 77c(b), 77d(2), 77s and 77z-3.
    \88\ 15 U.S.C. 80a-38(a).
    \89\ 15 U.S.C. 80b-11(a).
---------------------------------------------------------------------------

List of Subjects in 17 CFR Parts 230, 239, 270 and 275

    Reporting and recordkeeping requirements, Securities.

    For the reasons set out above, the Commission amends Title 17, 
Chapter II of the Code of Federal Regulations as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
1. The general authority citation for Part 230 is revised to read as 
follows:

    Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, unless otherwise noted.
* * * * *

Sec.  230.144  [Amended]

0
2. Amend Sec.  230.144, paragraph (a)(3)(viii), by removing the 
reference to ``4(6) (15 U.S.C. 77d(6))'' and adding in its place ``4(5) 
(15 U.S.C. 77d(5))''.

Sec.  230.155  [Amended]

0
3. Amend Sec.  230.155, paragraph (a), by removing the references to 
``4(6)'' and ``77d(6)'' and adding in their places ``4(5)'' and 
``77d(5)'', respectively.

0
4. Amend Sec.  230.215 by revising paragraph (e) to read as follows:

Sec.  230.215  Accredited investor.

* * * * *
    (e) Any natural person whose individual net worth, or joint net 
worth with that person's spouse, exceeds $1,000,000.
    (1) Except as provided in paragraph (e)(2) of this section, for 
purposes of calculating net worth under this paragraph (e):
    (i) The person's primary residence shall not be included as an 
asset;
    (ii) 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, shall not be 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

[[Page 81806]]

time, other than as a result of the acquisition of the primary 
residence, the amount of such excess shall be included as a liability); 
and
    (iii) Indebtedness that is secured by the person's primary 
residence in excess of the estimated fair market value of the primary 
residence shall be included as a liability.
    (2) Paragraph (e)(1) of this section will not apply to any 
calculation of a person's net worth made in connection with a purchase 
of securities in accordance with a right to purchase such securities, 
provided that:
    (i) Such right was held by the person on July 20, 2010;
    (ii) The person qualified as an accredited investor on the basis of 
net worth at the time the person acquired such right; and
    (iii) The person held securities of the same issuer, other than 
such right, on July 20, 2010.
* * * * *

0
5. Amend Part 230 by removing the authority citation after the 
undesignated center heading ``Regulation D--Rules Governing the Limited 
Offer and Sale of Securities Without Registration Under the Securities 
Act of 1933'' and preliminary notes preceding Sec. Sec.  230.501 to 
230.508.

0
6. Amend Sec.  230.501 by:
0
a. Revising paragraph (a)(5); and
0
b. Removing the word ``principal'' and adding in its place the word 
``primary'' in paragraph (e)(1)(i).
    The revision reads as follows:

Sec.  230.501  Definitions and terms used in Regulation D.

* * * * *
    (a) * * *
    (5) Any natural person whose individual net worth, or joint net 
worth with that person's spouse, exceeds $1,000,000.
    (i) Except as provided in paragraph (a)(5)(ii) of this section, for 
purposes of calculating net worth under this paragraph (a)(5):
    (A) The person's primary residence shall not be included as an 
asset;
    (B) 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, shall not be included as a liability 
(except that if the amount of such indebtedness outstanding at the time 
of 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 shall be included as a liability); 
and
    (C) Indebtedness that is secured by the person's primary residence 
in excess of the estimated fair market value of the primary residence 
at the time of the sale of securities shall be included as a liability;
    (ii) Paragraph (a)(5)(i) of this section will not apply to any 
calculation of a person's net worth made in connection with a purchase 
of securities in accordance with a right to purchase such securities, 
provided that:
    (A) Such right was held by the person on July 20, 2010;
    (B) The person qualified as an accredited investor on the basis of 
net worth at the time the person acquired such right; and
    (C) The person held securities of the same issuer, other than such 
right, on July 20, 2010.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

0
7. The general authority citation for Part 239 is revised to read as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78o-7 note, 78u-5, 78w(a), 78ll, 
78mm, 80a-2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 
80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *

Sec.  239.500  [Amended]

0
8. Amend Sec.  239.500 by removing the reference to ``4(6)'' and adding 
in its place ``4(5)'' in the heading and in the first sentence of 
paragraph (a)(1).

0
9. Amend Item 6 in Form D (referenced in Sec.  239.500) by:
0
a. Removing the phrase ``Securities Act Section 4(6)'' and adding in 
its place ``Securities Act Section 4(5)'' next to the appropriate check 
box; and
0
b. Removing the reference to ``4(6)'' and adding in its place ``4(5)'' 
in the first sentence of the first paragraph of the General 
Instructions.

    Note:  The text of Form D does not, and the amendments will not, 
appear in the Code of Federal Regulations.

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

0
10. The general authority citation for Part 270 continues to read in 
part as follows:

    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *

Sec.  270.17j-1  [Amended]

0
11. Amend Sec.  270.17j-1, paragraph (a)(8), by removing the references 
to ``4(6)''and ``77d(6)'' and adding in their places ``4(5)'' and 
``77d(5)'', respectively.

PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940

0
12. The authority citation for Part 275 continues to read in part as 
follows:

    Authority:  15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless 
otherwise noted.
* * * * *

Sec.  275.204a-1  [Amended]

0
13. Amend Sec.  275.204a-1, paragraph (e)(7) by removing the references 
to ``4(6)'' and ``77d(6)'' and adding in their places ``4(5)''and 
``77d(5)'', respectively.

    By the Commission.

     Dated: December 21, 2011.
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-33333 Filed 12-28-11; 8:45 am]
BILLING CODE 8011-01-P