[Federal Register Volume 76, Number 20 (Monday, January 31, 2011)]
[Proposed Rules]
[Pages 5307-5317]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-1922]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 230, 239, 270, and 275
[Release Nos. 33-9177; IA-3144; IC-29572; File No. S7-04-11]
RIN 3235-AK90
Net Worth Standard for Accredited Investors
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: We are proposing amendments to the accredited investor
standards in our rules under the Securities Act of 1933 to reflect the
requirements of Section 413(a) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act. Section 413(a) 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 statute, but Section 413(a) also requires us to revise our
current Securities Act rules to reflect the new standard. We also are
proposing technical amendments to Form D and a number of our rules to
conform them to the language of Section 413(a) 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: Comments should be received on or before March 11, 2011.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an e-mail to [email protected]. Please include
File Number S7-04-11 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-04-11. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Anthony G. Barone, Special Counsel, or
Gerald J. Laporte, Chief, Office of Small Business Policy, at (202)
551-3460, Division of Corporation Finance, U.S. Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-3628.
SUPPLEMENTARY INFORMATION: We are requesting public comment on proposed
amendments to Rule 144(a)(3)(viii),\1\ Rule 155(a),\2\ Rule 215,\3\ and
Rule 501(a)(5) \4\ of Regulation D \5\ of our general rules under the
Securities Act of
[[Page 5308]]
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) Proposed Language
(2) Other Issues Considered
(B) Technical and Conforming Amendments
III. General Request for Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Consideration of Burden on Competition and Promotion of
Efficiency, Competition and Capital Formation
VII. Initial Regulatory Flexibility Act Analysis
VIII. Small Business Regulatory Enforcement Fairness Act
IX. Statutory Authority and Text of Proposed Amendments
I. Background and Summary
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Dodd-Frank Act'') became law on July 21, 2010.\13\ Among other
things, the Dodd-Frank Act changed certain legal requirements governing
private and other limited offers and sales of securities without
registration under the Securities Act.
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\13\ Public Law 111-203, 124 Stat. 1376.
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Section 413(a) of the Dodd-Frank Act requires us to adjust the net
worth standards for accredited investors in our rules under the
Securities Act.\14\ These standards delineate investors to whom issuers
may sell securities in specified private and other limited offerings
without registration of the offering under the Securities Act. The
Dodd-Frank Act requires us to adjust the net worth standards in these
rules that apply to a natural person individually, or jointly with the
spouse of that person, to ``more than $1,000,000 * * * excluding the
value of the primary residence of such natural person.'' \15\
Previously, these standards required a minimum net worth of more than
$1,000,000, but permitted the primary residence to be included in
calculating net worth.\16\ 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.
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\14\ Id. Sec. 413(a), 124 Stat. 1577 (to be codified at 15
U.S.C. 77b note).
\15\ 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.
\16\ See 17 CFR 230.215(e), 230.501(a)(5) (2010).
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In addition, 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. We are not proposing to make revisions to the definitions
of ``accredited investor'' that are not required by the Dodd-Frank Act
at this time, but may consider doing so in future rulemaking. 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.'' \17\ The study is
due three years after enactment of the legislation. We expect that the
results of this study will inform any future rulemaking in this area
that takes place after the study is completed.\18\
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\17\ Public Law 111-203, Sec. 415, 124 Stat. 1376, 1578 (to be
codified at 15 U.S.C. 80b-18c).
\18\ To facilitate public input on its Dodd-Frank Act rulemaking
before issuance of rule proposals, the Commission has provided a
series of e-mail links, organized by topic, on its Web site at
http://www.sec.gov/spotlight/regreformcomments.shtml. In this
release, we refer to comment letters we received in response to this
invitation as ``advance comment letters.'' The advance comment
letters we received in anticipation of this rule proposal,
concerning revisions to the accredited investor net worth standards
under Section 413(a) of the Dodd-Frank Act, are available at http://www.sec.gov/comments/df-title-iv/accredited-investor/accredited-investor.shtml. One of those comment letters, from the North
American Securities Administrators Association, Inc. (``NASAA''),
urged us to modify the accredited investor definition to incorporate
an ``investments owned'' standard. See Advance Comment Letter from
NASAA (Nov. 4, 2010) (available at http://www.sec.gov/comments/df-title-iv/accredited-investor/accredited-investor-11.pdf). This topic
may be considered in connection with our future review of the
definition of ``accredited investor'' and any resultant rulemaking.
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Section 944 of the Dodd-Frank Act deleted former Section 4(5) of
the Securities Act and renumbered former Section 4(6) as Section
4(5).\19\ Former Section 4(6) provides an exemption from the
registration requirements of the Securities Act for certain limited
offerings to accredited investors if there is no advertising or public
solicitation by the issuer. Our proposals include technical corrections
to cross-references necessitated by this change.\20\
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\19\ Public Law 111-203, Sec. 944, 124 Stat. 1376, 1897
(renumbering Securities Act Section 4(6), 15 USC 77d(6) (2006), as
Section 4(5), 15 USC 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 USC 77d(6) (2006).
\20\ Section 926 of the Dodd-Frank Act requires the Commission
to revise the standards for offerings under Rule 506 of Regulation
D, 17 CFR 230.506, to impose certain ``bad actor''
disqualifications. We will propose those changes in a subsequent
rulemaking.
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II. Discussion
(A) Net Worth Standard for Accredited Investors
(1) Proposed Language
As discussed above, Section 413(a) of the Dodd-Frank Act requires
us to adjust the net worth standards for an accredited investor in our
Securities Act rules that apply to any natural person individually, or
jointly with the spouse of that person, to ``more than $1,000,000 * * *
excluding the value of the primary residence of such natural person.''
Previously, these standards required a minimum net worth of more than
$1,000,000, but permitted the primary residence to be included in
calculating net worth. The relevant rules are Securities Act Rules 501
and 215.\21\
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\21\ 17 CFR 230.501(a)(5) and 230.215(e) (2010).
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Rule 501 sets the standards for accredited investor status under
certain exemptive provisions for private and other limited offerings
under Regulation D. Rule 215 defines the term ``accredited investor''
under Section 2(a)(15) of the Securities Act.\22\ 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).\23\ While Regulation
D is frequently relied
[[Page 5309]]
upon,\24\ exclusive reliance on Section 4(5) is rare.\25\
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\22\ 15 U.S.C. 77b(a)(15).
\23\ 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.
\24\ In fiscal year 2010, we received 16,856 initial filings on
Form D notifying us of a claim 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.
\25\ 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%, claimed the Section 4(5) exemption exclusively. The other
844 of these Form D filings indicated that both Section 4(5) and a
Regulation D exemption were being relied upon.
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Neither the Securities Act nor our rules promulgated under the
Securities Act define the term ``net worth.'' The conventional or
commonly understood meaning of the term is the difference between the
value of a person's assets and the value of the person's
liabilities.\26\
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\26\ See, e.g., Interpretive Release on Regulation D, Release
No. 33-6455 (Mar. 3, 1983) [48 FR 10045] (Questions 21 and 45). See
also Barron's Financial Guides, Dictionary of Finance and Investment
Terms, at 457 (7th ed. 2006).
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The proposed amendments would set the same standard under both Rule
501 and Rule 215 for individuals to qualify as accredited investors on
the basis of net worth, either individually or with their spouses.\27\
The amendments would implement Section 413(a) by adding to the relevant
rules the language from Section 413(a)--``excluding the value of the
primary residence of such natural person''--after the requirement that
the investor's net worth ``exceeds $1,000,000'' currently in the rules.
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\27\ Historically, we have maintained identical accredited
investor standards under both rules.
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In addition, our proposed amendments would add, after the Dodd-
Frank statutory language, the phrase ``calculated by subtracting from
the estimated fair market value of the property the amount of debt
secured by the property, up to the estimated fair market value of the
property.''As so amended, the accredited investor net worth standards
in the relevant rules would define as an accredited investor:
Any natural person whose individual net worth, or joint net
worth with that person's spouse, at the time of purchase, exceeds
$1,000,000, excluding the value of the primary residence of such
natural person, calculated by subtracting from the estimated fair
market value of the property the amount of debt secured by the
property, up to the estimated fair market value of the property.
The purpose of adding the phrase introduced by the words
``calculated by'' is to clarify that net worth is calculated by
excluding only the investor's net equity in the primary residence.\28\
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\28\ Soon after enactment of Section 413(a), the staff of the
Division of Corporation Finance issued the following interpretation:
Question: Under Section 413(a) of the Dodd-Frank Act, the net
worth standard for an accredited investor, as set forth in
Securities Act Rules 215 and 501(a)(5), is adjusted to delete from
the calculation of net worth the ``value of the primary residence''
of the investor. How should the ``value of the primary residence''
be determined for purposes of calculating an investor's net worth?
Answer: Section 413(a) of the Dodd-Frank Act does not define the
term ``value,'' nor does it address the treatment of mortgage and
other indebtedness secured by the residence for purposes of the net
worth calculation. As required by Section 413(a) of the Dodd-Frank
Act, the Commission will issue amendments to its rules to conform
them to the adjustment to the accredited investor net worth standard
made by the Act. However, Section 413(a) provides that the
adjustment is effective upon enactment of the Act. When determining
net worth for purposes of Securities Act Rules 215 and 501(a)(5),
the value of the person's primary residence must be excluded.
Pending implementation of the changes to the Commission's rules
required by the Act, the related amount of indebtedness secured by
the primary residence up to its fair market value may also be
excluded. Indebtedness secured by the residence in excess of the
value of the home should be considered a liability and deducted from
the investor's net worth.
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).
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We believe this approach is appropriate because it is consistent
with, and advances the regulatory purposes of, Section 413(a). It
reduces the net worth measure by the amount or ``value'' that the
primary residence contributed to the investor's net worth before
enactment of Section 413(a). Consequently, it removes the value of the
primary residence from net worth without reducing net worth by more
than the amount contributed by the residence before the amendment.\29\
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\29\ Moreover, this approach to calculating net worth is
generally consistent with the manner in which net worth has
conventionally been determined since the adoption of Regulation D in
1982, which served as the background for Congress when it enacted
Section 413(a).
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We note that some of our existing rules follow an approach similar
to our proposal in calculating net worth. For example, Rule 701 under
Regulation R, which provides for the exclusion of the value of a
person's primary residence in applying a net worth standard, provides
for the exclusion of ``associated liabilities,'' such as mortgages on
the property.\30\
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\30\ 17 CFR 247.701(d)(1)(A) (defining ``high net worth
customer'' as a natural person who, individually or jointly with his
or her spouse, has at least $5 million in net worth ``excluding the
primary residence and associated liabilities of the person and, if
applicable, his or her spouse''). Rule 701 was jointly adopted by
the Securities and Exchange Commission and the Federal Reserve Board
after consultation with and the concurrence of the Office of the
Comptroller of the Currency, the Federal Deposit Insurance
Corporation and the Office of Thrift Supervision. See Definitions of
Terms and Exemptions Relating to the ``Broker'' Exception for Banks,
Release No. 34-56501 (Sept. 24, 2007) [72 FR 56514 (Oct. 3, 2007)].
In addition, Rule 17a-3(a)(17)(i)(A) under the Exchange Act requires
exchange members, brokers, and dealers to make and keep records of
accounts of natural persons, including a record of the person's net
worth ``excluding the value of primary residence.'' 17 CFR 240.17a-
3(a)(17)(i)(A). Our Division of Trading and Markets, which
administers this rule, interprets this provision to exclude the
associated liabilities of the primary residence for purposes of the
net worth test.
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Under our proposed amendments, if an investor with a net worth of
$2 million (calculated in the conventional manner 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 would be
$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 proposed rule, exclusion of the value of the
primary residence would reduce the investor's net worth by the same
amount of $400,000.
We believe our approach is preferable to possible alternative
interpretations. One alternative interpretation, excluding the fair
market value of the residence without netting out the secured
indebtedness, would reduce the net worth of any investor who has a
mortgage by more than the amount that the primary residence contributed
to the investor's net worth before enactment of Section 413(a). In the
example above, if the new standard did not allow exclusion of the
associated indebtedness, removal of the primary residence would reduce
the investor's net worth by $1.2 million, for a revised net worth of
$800,000, since the entire fair market value of the house ($1.2
million) would be subtracted from the investor's net worth of $2
million and the $800,000 mortgage loan would still be included as a
liability in the calculation.
We believe that following this alternative approach and reducing
the net worth by the value of the primary residence without excluding
associated indebtedness would not accord with the manner in which net
worth was determined before enactment of Section
[[Page 5310]]
413(a).\31\ Absent legislative history suggesting Section 413(a) was
clearly intended to be implemented in that fashion, we believe our
proposed approach is appropriate and consistent with the purpose of
Section 413(a)--to remove the ``value of the primary residence'' from
the calculation of net worth for accredited investor
determinations.\32\
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\31\ In addition, this alternative approach would also result in
a substantially greater reduction in the pool of accredited
investors. Using data from the 2007 Federal Reserve Board Survey of
Consumer Finances, the latest data available, our Division of Risk,
Strategy and Financial Innovation estimates that 10,496,312 of the
116,122,128 U.S. households (9.04%) qualified for accredited
investor status on the basis of the net worth standard before it was
modified by Section 413(a) of the Dodd-Frank Act; 7,604,374 (6.55%)
would have qualified on the basis of the net worth standard after
modification based on Section 413(a), as interpreted by our proposed
approach to exclude from the net worth calculation both the
estimated fair market value of the primary residence and all
indebtedness secured by the residence up to the fair market value of
the property; and 6,858,335 (5.91%) would have qualified if we
adopted a standard based on the alternative interpretation of
Section 413(a) to exclude from the net worth calculation the fair
market value of the primary residence but not any indebtedness
secured by the residence. More information regarding the survey may
be obtained at http://www.federalreserve.gov/pubs/oss/oss2/scfindex.html. See also note 49 below and accompanying text.
\32\ Section 413(a) was one element of an amendment introduced
on the floor of the Senate and adopted by voice vote. See 156 Cong.
Rec. S3817 (daily ed. May 17, 2010). The amendment, as explained by
Senator Dodd, id. at S3813, would (1) ``disqualify felons and other
`bad actors' who have violated Federal and State securities laws
from continuing to take advantage of the rule 506 private placement
process,'' (2) ``amend the `accredited investor' wealth threshold by
excluding the value of an investor's primary residence,'' and (3)
direct the SEC ``to review the [accredited investor] financial
standards at least [every] 4 years,'' and replaced a provision that
would have required the Commission to adjust both the net worth and
the income standards for accredited investors to reflect inflation
from the date of their determination in 1982 to the date of
enactment of the Dodd-Frank Act in 2010. See Amendment as Substitute
No. 3789 to S. 3217, 111th Cong., 2d Sess. Sec. 412 (available at
http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:s3217as.txt.pdf). The legislative history does
not suggest that the amount of associated mortgage debt should not
also be deleted in calculating net worth.
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Under our proposed amendments, indebtedness secured by the primary
residence would be netted against the value of the primary residence
only up to the fair market value of the property. For example, if an
investor with a net worth of $2 million has a primary residence with an
estimated fair market value of $600,000 and secured indebtedness of
$800,000, a $600,000 portion of the secured indebtedness would be
netted against the entire $600,000 value of the house, so the
investor's net worth for purposes of the new accredited investor
standard would remain at $2 million. The $200,000 in secured
indebtedness in excess of the value of the property would already have
been accounted for (i.e., subtracted from the value of other assets) in
determining the investor's net worth.
In comparison, another possible interpretation of Section 413(a)
would be to exclude from net worth both the fair market value of the
primary residence and all indebtedness secured by the primary
residence, regardless of whether the indebtedness exceeds the fair
market value of the property. This alternative interpretation is the
same as our proposal when the value of the property exceeds the secured
indebtedness, but provides a different result if the amount of secured
debt exceeds the value of the property (i.e., the case of an underwater
mortgage). For example, under this interpretation, if an investor with
a net worth of $2 million has a primary residence with an estimated
fair market value of $600,000 and a mortgage loan of $800,000 and no
other secured indebtedness, the investor's net worth for purposes of
the new accredited investor standard would be $2,200,000. Net worth is
effectively increased over the conventional net worth calculation by
$200,000 (the amount the underwater mortgage exceeds the value of the
property). We do not believe, however, that it would be appropriate for
us to implement Section 413(a) in a way that results in increased net
worth (compared to a conventional calculation) for investors with
underwater mortgages.
As noted above, the requirement to exclude the value of the primary
residence became operative when the statute was enacted. Therefore, we
are not making any special provision for the transition to the new
requirement. We are nevertheless specifically requesting comment below
on whether some transition provisions would be appropriate.
(2) Other Issues Considered
We considered a number of issues described below, as to which the
proposed amendments reflect our preliminary determinations. These
issues are the subject of specific requests for comment at the end of
this section.
Defining ``Primary Residence.'' We considered proposing amendments
that would have defined the term ``primary residence'' for purposes of
the rules we are amending. While we are soliciting comment on whether a
definition should be added to the rule, the proposal does not contain a
definition, consistent with our past policies in this area,\33\ and in
an attempt to avoid unnecessary complexity.\34\
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\33\ 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) & 17 CFR 210.2-
01(c)(1)(ii)(A)(4). Regulation D also does 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). There, Regulation D uses 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 propose to change this reference from ``principal residence'' to
``primary residence'' so that it conforms to the terminology of the
Dodd-Frank Act. See note 44 below and accompanying text.
\34\ We followed this approach when we adopted Regulation D
originally and decided not to define the term ``income,'' an element
of another of our accredited investor standards. At the time, we
explained that, ``[r]ather than adopting a definition [of the term
``income,'' we] determined to utilize a flexible approach'' to avoid
problems with a defined term. Revision of Certain Exemptions From
Registration for Transactions Involving Limited Offers and Sales,
Release No. 33-6389 (Mar. 8, 1982) [47 FR 11251, 11255 (Mar. 18,
1982)].
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Issuers and investors should be able to use the commonly understood
meaning of ``primary residence''--the home where a person lives most of
the time.\35\ If additional analysis is needed under complex or unusual
circumstances, helpful guidance may be found in rules that apply in
other contexts, such as income tax rules and rules that apply when
acquiring a mortgage loan for a primary residence, which often bears a
lower interest rate than other mortgage loans.\36\
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\35\ See IRS Publication 523, Selling Your Home 2 (Mar. 8, 2010)
(``Usually, the home you live in most of the time is your main home
* * *'').
\36\ For example, the IRS Publication Selling Your Home lists
the following factors to be used, in addition to the amount of time
a person lives in each of several homes, to determine a person's
``principal residence'' under Section 121 of the Internal Revenue
Code, 26 U.S.C. 121: place of employment; location of family
members' main home; mailing address for bills and correspondence;
address listed on federal and state tax returns, driver's license,
car registration, and voter registration card; location of banks
used and recreational clubs and religious organizations. Id. at 4.
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Proceeds of Debt Secured by Primary Residence Incurred to Invest in
Securities. The North American Securities Administrators Association
(``NASAA'') has recommended that we not permit the exclusion of debt
secured by a primary residence from the calculation of net worth if
proceeds of the debt are used to invest in securities.\37\ NASAA is
concerned that, in the absence of such a rule, an ``unscrupulous
salesperson might encourage a person with a significant amount of
equity in the person's home, which is not uncommon for older
[[Page 5311]]
investors, to take out a mortgage on the residence in order to
manipulate their status under the accredited investor test and to use
the proceeds to invest in what would otherwise be unsuitable private
placement securities.'' \38\ We agree that such actions would raise
serious concerns under the federal securities laws. If broker-dealer
sales personnel engage in this type of activity, their conduct can be
addressed under the standards governing broker-dealer sales
practices.\39\ However, we preliminarily do not believe that the
potential for inappropriate sales practices, whether by issuers or by
broker-dealers, necessitates adding significant complexity to the
calculation of net worth. As noted above, Regulation D is designed to
be relatively straightforward to apply, and we are concerned that a
rule that attempts to trace the use of mortgage or home equity loan
proceeds and to distinguish between permissible and impermissible uses
of proceeds would introduce undue complexity into Regulation D. We
request public comment on this preliminary judgment below.
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\37\ Advance Comment Letter from NASAA, note 18 above.
\38\ Id. at 2.
\39\ 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.
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We also are soliciting comment on whether the proposed amendments
should contain a timing provision in order to prevent investors from
inflating their net worth by purchasing assets with the proceeds of
indebtedness secured by their homes with the intent to qualify as
accredited investors and purchase Regulation D securities. For example,
the proposed amendments could provide that the net worth calculation
must be as of a date 30 or 60 days before the sale of the securities,
as well as at the time of sale. Because we have some concern that this
could complicate issuers' and investors' calculations, particularly as
the date of the sale may not be known sufficiently in advance, we are
not proposing such a timing provision, but request comment on this
preliminary judgment.
Transition and Other Rules on Subsequent Investments. We are not
proposing any special rules for transition to the new accredited
investor net worth standards, since these new standards were effective
upon enactment of the Dodd-Frank Act. Under the current rules, a
company or fund is not permitted to treat an investor as accredited if
the investor subsequently loses that status, even if the investor has
previously invested in the company or fund at a time when it satisfied
the accredited investor standard. Investors must satisfy the applicable
accredited investor income or net worth standard in effect at the time
of every exempt sale of securities to the investor that is made in
reliance upon the investor's status as such. The proposed amendments
would not change this situation.
We nevertheless are seeking comment below on whether some
transition and other rules might be appropriate to facilitate
subsequent investments by an investor who previously qualified as
accredited but was disqualified by the change effected by the Dodd-
Frank Act. For example, an investor that qualified as an accredited
investor in a previous sale under Regulation D before enactment of the
Dodd-Frank Act may wish to invest in the same company or fund in order
to retain its proportionate interest in the company or fund or to
exercise rights that have arisen because of that interest.\40\ Or a
company may wish to make a rights offering to current investors who
invested as accredited investors. In this case, the company may not
wish to be subject to the additional information requirements it may
incur under Regulation D if it offers and sells securities to non-
accredited investors,\41\ and the company may be precluded from making
the offering if the number of non-accredited investors exceeds the
limit of 35 non-accredited investors imposed in Rule 505 and Rule 506
offerings. In some of these cases, the investor may have spent a
substantial amount of time and money performing due diligence on the
company or fund before his or her previous investments and may be
familiar with the issuer as an existing investor. Under these
circumstances, some have argued that the investor should be able to
invest again as an accredited investor even if the investor does not
satisfy the standards applicable at the time of the subsequent
investment.\42\
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\40\ Such contractual rights may include preemptive rights,
rights of first refusal, rights of co-sale, buy-sell agreements and
so-called pay to play provisions that provide for dilution or other
adverse consequences to affected investors who do not fund capital
calls or otherwise reinvest in future rounds of financing.
\41\ See CFR 230.502(b)(1).
\42\ A speaker at the SEC Forum on Small Business Capital
Formation conducted on November 18, 2010 suggested that an investor
that qualified as an accredited investor when initially investing in
a company or fund should be able to continue to invest in future
offerings of that issuer, even if the investor no longer meets any
new elevated accredited investor standards. See Record of
Proceedings of 29th Annual SEC Government-Business Forum on Small
Business Capital Formation, at 18 (Nov. 18, 2010) (remarks of Alan
J. Berkeley) (available at http://www.sec.gov/info/smallbus/sbforumtrans-111810.pdf).
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Specific Requests for Comment
1. Should the value of the residence be calculated by netting out
the debt secured by the residence, as proposed? Or would it be more
appropriate to exclude the entire fair market value of the residence
from net worth, without netting out any associated debt?
2. Would it be more appropriate to substitute the word ``equity''
for the word ``value'' when referring to the primary residence in our
accredited investor net worth standards?
3. Should we interpret Section 413(a) to exclude 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 property?
4. Is another interpretation of Section 413(a) superior to those we
discussed?
5. Should we define the term ``primary residence'' for purposes of
our accredited investor net worth rules? If we define the term, should
we use a definition under the federal income tax code? If so, should we
also incorporate into our definition a reference to guidelines issued
under the federal income tax code? Alternatively, should we define
``primary residence'' as the commonly understood meaning of the term--
the home where a person lives most of the time? What alternative
definitions would you recommend? For example, should we define the term
by listing several factors to consider? Would the factors from the IRS
publication listed in note 35 be the appropriate factors, or are there
different factors that should be included?
6. Should we require inclusion of debt secured by a primary
residence in our proposed accredited investor net worth standard if
proceeds of the debt are used to invest in securities? How would these
proceeds be traced? Would companies and their prospective investors
find this standard workable? Should distinctions be made among
different kinds of securities? Are there other assets besides
securities that should be taken into account?
7. Should the rule provide that the calculation of net worth must
be made as of a specified date before the sale of securities under
Regulation D, for example, 30, 60 or 90 days, as well as
[[Page 5312]]
at the time of sale? If not, would investors be likely to inflate their
net worth by borrowing against their homes to attain accredited
investor status? If we required that the net worth calculation be made
a significant period of time in advance of the sale, would such a
requirement make the calculation unduly complex or otherwise make
exempt offerings to accredited investors less useful for issuers?
8. Issuers and investors have calculated net worth under the
Regulation D accredited investor standards for many years without
specific instructions in the rules on how the calculation should be
performed. Would guidance in the rules on how to calculate net worth,
in addition to the new standards governing valuing the primary
residence and treating related mortgage debt, be helpful? For example,
should we adopt rules specifying what should be included as assets and
debt, and how various kinds of assets should be valued? If so, what
additional rules would be appropriate?
9. Should we adopt any transition or other rules providing that an
investor who previously qualified as an accredited investor before
enactment of Section 413(a), or adoption of the proposed amendments,
may continue to qualify as such for purposes of subsequent or ``follow-
on'' investments, such as investments to protect its proportionate
interest in a company or fund or to exercise rights that arise because
of that interest, or would that be inconsistent with the purposes of
Section 413(a)? If we should adopt such an approach, are there other
types of investments that should qualify for such treatment? Would
investors' ability to protect their then-existing investments be
inappropriately adversely affected if we did not provide such
treatment? Would issuers' ability to raise capital be inappropriately
impeded if we did not provide such treatment? If we did this, should we
limit the amount of permissible follow-on investments, such as limiting
them to the amount necessary to protect the investor from dilution?
What conditions should we place on qualifying for such treatment? Is
this unnecessary because the Section 4(2) private placement exemption
may be available for sales to such an existing investor? Instead,
should we provide that an investor who previously qualified as an
accredited investor, but no longer qualifies as a result of Section
413(a), would not count towards the 35 non-accredited investor
limitation of Rules 505(b) and 506(b) \43\ for offerings by issuers in
which the investor held investments at the time the Dodd-Frank Act was
enacted?
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\43\ 17 CFR 230.505(b) and 230.506(c).
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(B) Technical and Conforming Amendments
In order to avoid confusion, we are proposing to change the
reference currently in Rule 501(e)(1)(i) of Regulation D to ``principal
residence'' so that it reads ``primary residence'' and conforms to the
language we are adding to Rule 501 to implement Section 413(a) of the
Dodd-Frank Act. We believe the terms are synonymous and should read the
same.\44\
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\44\ 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).
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Also to avoid confusion, we propose to revise 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 propose to
amend 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;
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. General Request for Comment
We request comment, both specific and general, on each component of
the proposals. We request and encourage any interested person to submit
comments regarding:
The proposals that are the subject of this release; and
Other matters that may have an effect on the proposals
contained in this release.
Comment is solicited from the point of view of both investors and
issuers, as well as of capital formation facilitators, such as broker-
dealers, and other regulatory bodies, such as state securities
regulators. Any interested person wishing to submit written comments on
any aspect of the proposal is requested to do so.
IV. Paperwork Reduction Act
The proposed amendments do not contain a ``collection of
information'' requirement within the meaning of the Paperwork Reduction
Act of 1995.\45\ Accordingly, the Paperwork Reduction Act is not
applicable.
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\45\ 44 U.S.C. 3501-3521.
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V. Cost-Benefit Analysis
A. Background and Summary of Proposals
As discussed above, we are proposing amendments to the accredited
investor standards in our rules under the Securities Act to reflect 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 the primary
residence. The substantive change to the net worth standards was
effective by operation of the Dodd-Frank Act upon enactment; however,
Section 413 also requires us to adjust the accredited investor
definitions in our Securities Act rules to reflect the new standard. We
therefore propose to revise Securities Act Rule 501(a)(5) of Regulation
D and Securities Act Rule 215(e) to reflect the new standard.
Our proposed revisions go beyond the minimum language necessary to
reflect the new standard by providing guidance on how to exclude the
value of the primary residence from the net worth calculation. This
language would explain that the value of the primary residence would be
``calculated by subtracting from the estimated fair market value of the
property the amount of debt secured by the property, up to the
estimated fair market value of the property.''
Our analysis here focuses on the costs and benefits to the economy
of including our proposed explanatory language, as compared to the
alternatives discussed, rather than the costs and benefits of the new
heightened accredited investor net worth standard, which was mandated
by Congress in Section 413(a) of the Dodd-Frank Act.
The language we propose reflects our exercise of discretion in
choosing one interpretation of the statutory language set forth in
Section 413(a) over two other possible interpretations. These two other
interpretations of the Section 413(a) language are: (1) Excluding from
[[Page 5313]]
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 residence.
We are also proposing technical changes to Form D and a number of
rules to conform them to the Dodd-Frank Act, in all but one instance to
revise cross-references to former Section 4(6) of the Securities Act,
which was renumbered Section 4(5) in Section 944 of the Dodd-Frank Act.
We have identified certain benefits and costs that may result from
the proposed explanatory language. We encourage the public to identify,
discuss, analyze and supply relevant data regarding these or any
additional benefits and costs in comment letters on these proposed
amendments.
B. Benefits
We preliminarily believe the proposed explanatory language provides
the most appropriate interpretation of the words of Section 413(a). The
proposed explanatory language would result in the following benefits:
We believe the proposed amendments most accurately reflect
the manner in which net worth has conventionally been determined and
understood. We believe investors and issuers would benefit from
implementing rules that are easy to understand and consistent with
conventional net worth calculation concepts.\46\
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\46\ See note 26 above and accompanying text.
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The interpretation reflected in the proposed amendments
would result in a smaller reduction in the pool of accredited investors
than the first alternative interpretation.\47\ 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.
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\47\ See note 31 above.
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Limiting the amount of debt secured by the primary
residence that may be excluded from net worth to the estimated fair
market value of the property, as proposed, would limit investors'
incentives to incur indebtedness secured by their primary residence in
an amount greater than the value of their property. This result is
preferable to an alternative possible interpretation of Section 413(a)
that would allow investors to exclude both the fair market value of the
property and all indebtedness secured by the property, regardless of
whether such indebtedness exceeded the fair market value of their
property. Under this alternative interpretation, investors with
underwater mortgages would have a higher net worth than they would
under a conventional calculation, since all such indebtedness would be
excluded in determining whether they qualify as accredited investors on
the basis of their net worth. In contrast, under our proposal, the
investor's net worth would continue to be reduced to reflect any
liability in the amount of any shortfall between the mortgage
indebtedness and the estimated fair market value of the property.
C. Costs
Like our analysis of the benefits, our analysis of the costs
focuses on the costs attributable to our proposed language on how to
calculate the ``value of the primary residence'' to be excluded from
the net worth calculation. Many of the costs of our proposal are
dependent on a number of factors, but may include the following:
The proposed amendments could encourage investors to
obtain indebtedness secured by their primary residence up to the
estimated fair market value of the property with the primary motive to
inflate their net worth in order to satisfy the new heightened
accredited investor net worth standard in Section 413(a) by purchasing
assets unrelated to their home, such as stocks, bonds, cars, etc. The
net effect would be to increase net worth under the rule, since these
assets, unrelated to the home, would be included in their net worth
calculation, but the indebtedness secured by the primary residence to
acquire these assets would be excluded from the net worth calculation
under our proposed amendments.\48\
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\48\ NASAA has recommended that we not permit the exclusion of
debt secured by a primary residence from the calculation of net
worth if the proceeds of the debt are used to invest in securities.
See Advance Comment Letter from NASAA, note 18 above, and note 37
above and accompanying text. We have solicited comment above on this
issue.
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The proposed approach would require that an investor's net
worth reflect the amount that the investor's secured indebtedness
exceeds the estimated fair market value of the property. While the 2007
Federal Reserve Board Survey of Consumer Finances does not indicate
that there was any difference in the number of households that would
qualify under the two standards,\49\ given recent downward trends in
real estate values, our proposed approach could 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. This could result in increased costs for companies
and funds that are seeking accredited investors to participate in their
exempt offerings.
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\49\ Based on its analysis of the data from the 2007 Federal
Reserve Board Survey of Consumer Finances, discussed in note 31
above, our staff estimates that approximately 7.6 million households
would have qualified for accredited investor status under both our
proposed approach and the second alternative interpretation of
Section 413(a), which would exclude from the net worth calculation
both the fair market value of the primary residence and all
indebtedness secured by the residence, regardless of whether the
indebtedness exceeds the fair market value of the property.
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The proposed approach involves more complex calculations
than the two alternative possible approaches we have identified. The
proposed approach involves estimating the fair market value of the
investor's primary residence, subtracting the indebtedness secured by
the residence, and subtracting the difference or net amount from the
investor's net worth calculation. Both of the alternative net worth
calculations, however, 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 interpretation also ignoring the
indebtedness secured by the primary residence.
D. Request for Comment
We solicit comments on the costs and benefits of the proposed
amendments. We request your views on the costs and benefits described
above, as well as on any other costs and benefits that could result
from the adoption of our proposals. We encourage the public to
identify, discuss, analyze, and supply relevant data regarding these or
any additional costs and benefits in comment letters.
In general, we request comment on all aspects of this cost-benefit
analysis, including identification of any additional costs or benefits
of the proposals not already identified, that may result from the
adoption of these proposed amendments. We request that comment letters
responding to these requests provide empirical data and other factual
support for their views to the extent possible.
[[Page 5314]]
VI. Consideration of Burden on Competition and Promotion of Efficiency,
Competition and Capital Formation
Section 2(b) of the Securities Act \50\ 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. We believe our
proposed amendments may facilitate capital formation and promote
efficiency. We do not anticipate that the proposed amendments would
have any effects on competition.
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\50\ 15 U.S.C. 77b(b).
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We believe the proposed amendments impose no burden on efficiency,
competition and capital formation beyond what is required by
implementation of the Dodd-Frank Act. As discussed in the cost-benefit
analysis in Part V above, however, the language of Section 413(a) could
be subject to alternative interpretations if our rules do not provide
guidance on how to calculate the value of the primary residence. In
this regard, we propose to add explanatory language to our rules on how
to calculate and exclude the value of the primary residence in
determining whether a person qualifies under the accredited investor
net worth standard. We believe these proposed amendments further the
purposes underlying the requirements of Section 413(a) of the Dodd-
Frank Act.
The proposed explanatory language states that the value of the
primary residence would be ``calculated by subtracting from the
estimated fair market value of the property the amount of debt secured
by the property, up to the estimated fair market value of the
property.'' As described above, we believe this approach is consistent
with Section 413(a) of the Dodd-Frank Act, as well as with the
conventional and commonly understood method of determining net worth,
and, as a result, is preferable to an alternative approach that would
exclude from net worth the fair market value of the primary residence,
without netting out indebtedness secured by the primary residence. To
the extent that exempt offerings to accredited investors are less
costly for issuers to complete compared to registered offerings, since
the explanatory language would reduce the size of the accredited
investor pool to a lesser extent than the alternative approach,\51\
issuers conducting these exempt offerings potentially could experience
greater cost savings than under the alternative interpretation.
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\51\ See note 31 above and accompanying text.
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The least restrictive approach to excluding the value of the
primary residence under Section 413(a) would be to exclude from net
worth the fair market value of the primary residence and all
indebtedness secured by the primary residence, regardless of whether
the debt exceeds the fair market value of the property. Based on the
survey data, this approach would not result in a larger pool of
eligible accredited investors than under our proposal, and therefore
would not appear to result in additional cost savings for capital
raising transactions by issuers relying on exempt sales to accredited
investors compared to our proposal.\52\
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\52\ See note 49 above and accompanying text.
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We do not believe the proposed amendments place any significant
burden on or otherwise affect competition beyond what is required by
the Congressionally-mandated requirements of Section 413(a). The
proposed amendments would apply equally to all investors and issuers
participating in exempt offerings under Regulation D and Section 4(5).
Nevertheless, we request comment on our proposal in the event members
of the public perceive it as advantaging one group or category of
issuers or investors over another.
We believe the proposed amendments may positively affect efficiency
and capital formation. Providing clear guidance on how to calculate and
exclude the value of the primary residence, we believe, should
generally benefit investors and issuers by making the requirements of
Section 413(a) easier to apply. 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, as well as the risk
of sales by issuers to investors who do not meet the new heightened
accredited investor net worth standards. Avoiding this latter problem
would also serve to lower the risk that an issuer may need to make a
rescission offer. Greater clarity and certainty in our accredited
investor net worth standards also should foster greater confidence in
our private placement markets and ultimately reduce the cost of
capital, promoting increased capital formation.
We request comment on whether the proposed amendments, if adopted,
would promote or burden efficiency, competition and capital formation.
Finally, we request those who submit comment letters to provide
empirical data and other factual support for their views if possible.
VII. Initial Regulatory Flexibility Act Analysis
This initial regulatory flexibility analysis has been prepared in
accordance with 5 U.S.C. 603. It relates to proposed amendments to our
accredited investor rules under the Securities Act to reflect the
requirements of Section 413(a) of the Dodd-Frank Act.
A. Reasons for the Proposed Action
The reason for the proposed 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 the 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 reflect the new standard, which we propose to do by
revising Securities Act Rule 501(a)(5) of Regulation D and Rule 215(e).
B. Objectives
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 also propose to add language explaining how to ``exclude
the value of the primary residence'' properly so that implementation
proceeds in the most efficient way possible, with a minimum amount of
uncertainty. We believe this proposal will reduce the cost of exempt
offerings under Regulation D and Section 4(5) by reducing uncertainty
among issuers and investors in interpreting the new heightened
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 this form of offering,
thereby potentially lowering the cost of capital generally, and
facilitating capital formation for smaller issuers, while protecting
investors.
[[Page 5315]]
We note that Section 413(a) of the Dodd-Frank Act does not
prescribe the method for calculating the value of the primary
residence, nor does it address specifically the treatment of mortgage
and other indebtedness secured by the residence for purposes of the net
worth determination. Accordingly, we have proposed to exercise our
discretion by adding explanatory language to the accredited investor
net worth standard stating that the value of the primary residence
should be calculated by subtracting from the estimated fair market
value of the property the amount of debt secured by the property, up to
the estimated fair market value of the property. We believe this
interpretation is consistent with conventional and commonly understood
methods of determining net worth, and is preferable to other possible
interpretations of the statutory language set forth in Section 413(a),
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 property.
C. Legal Basis
The amendments to the accredited investor net worth standards are
being proposed under the authority set forth in Sections 2(a)(15),
3(b), 4(2), 19, and 28 of the Securities Act and in Section 413(a) of
the Dodd-Frank Act, which is to be codified in a note to Section 2 of
the Securities Act, 15 U.S.C. 77b.
D. Small Entities Subject to the Proposed Rules
The proposals would 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.\53\ 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 proposed amendments would 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).
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\53\ 17 CFR 230.157.
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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 Sept. 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 reliable information on total assets to
determine if they are small entities for purposes of this analysis.
E. Reporting, Recordkeeping and Other Compliance Requirements
None of our proposed amendments would 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 proposed amendments merely adjust our rules so they reflect
the requirements of Section 413(a) of the Dodd-Frank Act. They would
not require any further disclosure than is currently required in
offerings made in reliance on Regulation D and Section 4(5).
F. Duplicative, Overlapping or Conflicting Federal Rules
We believe that there are no rules that conflict with or duplicate
the proposed amendments.
G. Significant Alternatives
The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish the stated objective of our
proposals, while minimizing any significant adverse impact on small
entities. In connection with the proposed 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 proposed amendments, or
any part thereof, for small entities.
With respect to the establishment of special compliance
requirements or timetables under our proposed amendments for small
entities, we do not think this is feasible or appropriate. As described
earlier, we believe our proposed amendments are preferable to other
possible interpretations of the statutory language set forth in Section
413(a) and are consistent with Congressional intent. Our proposals 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 proposals 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 and thereby
further 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 proposed rules
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 proposal seeks 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 the value and leaving
the method of attaining that end to the discretion of the issuer, as a
performance standard would do, would frustrate our purpose and deny
small entities and others of the benefits of certainty that the
proposal is designed to provide.
With respect to exempting small entities from coverage of these
proposed amendments, we believe such a proposal would increase rather
than decrease regulatory burdens on small entities. Our proposals are
designed to provide sufficient 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 would increase their
regulatory burdens and increase confusion. We have endeavored to
[[Page 5316]]
minimize the regulatory burden on all issuers, including small
entities, while meeting our regulatory objectives. Nevertheless, we
request comment on ways in which we could exempt small entities from
coverage of any aspects of the proposed amendments that members of the
public consider unduly onerous.
H. Request for Comment
We encourage comments with respect to any aspect of this initial
regulatory flexibility analysis. In particular, we request comments
regarding:
The number of small entities that may be affected by the
proposals;
The existence or nature of the potential impact of the
proposals on small entities discussed in this analysis; and
How to quantify the impact of the proposed amendments.
We request members of the public to submit comment letters on our
proposals and ask them to describe the nature of any impact on small
entities they identify and provide empirical data supporting the extent
of the impact. Such comments will be considered in the preparation of
the final regulatory flexibility analysis, if the proposals are
adopted, and will be placed in the same public file as comments on the
proposed amendments themselves.
VIII. Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996,\54\ a rule is ``major'' if it has resulted, or is likely
to result in:
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\54\ Public Law 104-121, tit. II, 110 Stat. 857 (1996).
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An annual effect on the economy of $100 million or more;
A major increase in costs or prices for consumers or
individual industries; or
Significant adverse effects on competition, investment or
innovation.
We request comment on whether our proposals would be a ``major
rule'' for purposes of SBREFA. We solicit comment and empirical data
on:
The potential effect on the U.S. economy on an annual
basis;
Any potential increase in costs or prices for consumers or
individual industries; and
Any potential effect on competition, investment or
innovation.
IX. Statutory Authority and Text of Proposed Amendments
We are proposing the amendments contained in this document under
the authority set forth in Sections 2(a)(15), 3(b), 4(2), 19 and 28 of
the Securities Act, as amended,\55\ Section 38(a) of the Investment
Company Act,\56\ Section 211(a) of the Investment Advisers Act \57\ and
Sections 413(a) and 944(a) of the Dodd-Frank Act.
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\55\ 15 U.S.C. 77b(a)(15), 77c(b), 77d(2), 77s and 77z-3.
\56\ 15 U.S.C. 80a-38(a).
\57\ 15 U.S.C. 80b-11(a).
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List of Subjects in 17 CFR Parts 230, 239, 270 and 275
Reporting and recordkeeping requirements, Securities.
For the reasons set out above, Title 17, Chapter II of the Code of
Federal Regulations is proposed to be amended as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
1. The general authority citation for Part 230 is revised to read
as follows:
Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r,
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w,
78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-37 and
Pub. L. 111-203, Sec. 413(a), 124 Stat. 1577 (2010) (15 U.S.C. 77b
note), unless otherwise noted.
* * * * *
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))''.
3. Amend Sec. 230.155, paragraph (a), by removing the references
to ``4(6)'' and ``77(d)(6)'' and adding in their places ``4(5)'' and
``77(d)(5)'', respectively.
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, at the time of purchase, exceeds
$1,000,000, excluding the value of the primary residence of such
natural person, calculated by subtracting from the estimated fair
market value of the property the amount of debt secured by the
property, up to the estimated fair market value of the property;
* * * * *
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.
6. Amend Sec. 230.501 by:
a. Revising paragraph (a)(5); and
b. Removing the word ``principal'' and adding in its place the word
``primary'' in paragraph (e)(1)(i);
The revision read 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, at the time of purchase, exceeds
$1,000,000, excluding the value of the primary residence of such
natural person, calculated by subtracting from the estimated fair
market value of the property the amount of debt secured by the
property, up to the estimated fair market value of the property;
* * * * *
PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
7. The general authority citation for Part 239 continues to read in
part as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3,
77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(e), 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.
* * * * *
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).
9. Amend Item 6 in Form D (referenced in Sec. 239.500) by:
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
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
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.
* * * * *
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.
[[Page 5317]]
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
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)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *
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: January 25, 2011.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-1922 Filed 1-28-11; 8:45 am]
BILLING CODE 8011-01-P