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News December 26, 2011 Issue

SEC Adopts Revised Net Worth Calculation for Accredited Investor Status, Still Waiting to Hear for Qualified Clients

The house is officially out.

Beginning on the February 27, 2012 effective date, it no longer will be permissible to use the value of the investor’s primary residence when calculating their net worth for the $1 million accredited investor net worth minimum.

On December 21 the SEC announced it had adopted revisions to the net worth calculation substantially as they had been proposed in January. The revised calculation amends Rules 215 and 501 under the Securities Act, as mandated by Section 413(a) of the Dodd-Frank Act (DFA).

Under the revised calculation, the value of an individual’s primary residence will not count as an asset when calculating net worth to determine "accredited investor" status.

While the value of a primary residence may not be considered an asset, any debt secured by that residence up to the residence’s fair market value is not considered a liability, unless the borrowing occurs in the 60 days preceding the purchase of securities in the exempt offering and is not in connection with the acquisition of the primary residence.

The amended rules also include grandfathering for existing investors and certain follow-on investments by those investors.

No effect on the performance fee rule.

This new calculation methodology is similar to, but should not be confused with, the calculation methodology proposed for the qualified client standard under the Advisers Act performance fee rule (Rule 205-3).

The "qualified client" net worth and assets under management thresholds were adjusted upward for inflation (to minimums of $2 million and $1 million, respectively) back in the summer and took effect on September 19. At the time those increases were proposed back in May, the SEC also proposed revisions to the calculation of net worth for qualified clients.

The net worth calculation for qualified clients would, similar to the newly adopted net worth calculation for accredited investors, also exclude the value of a primary residence from the client’s assets.

Until the SEC acts on the proposed amendments to the performance fee rule, the value of a primary residence may still be included in the calculation of a qualified client’s net worth.

If adopted as proposed, the performance fee rule amendments would provide that:

  • the value of a client’s primary residence would be excluded from the calculation of net worth;
  • assets under management would include unfunded capital commitments where a bona fide contractual commitment exists and the adviser reasonably believes the client can meet the commitment(s); and
  • current clients may remain in current investments, but would have to meet any new standard in effect at the time such client makes any new investments.