With the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 being signed into law earlier this year, there have been significant changes in the way the financial sector is regulated. However, the bulk of the new regulations will be coming online over the next 18 months.
“While the Act’s main focus is the soundness of the financial systems, it also impacts a broad spectrum of financial transactions, products and sector participants, including public and private companies seeking to raise capital through private placements,” says Edward Quinlisk, chair of the Securities Practice at McDonald Hopkins LLC.
Smart Business spoke with Quinlisk about how the Act will impact the way that companies do business.
What kinds of businesses will the Act impact?
The Act will impact not only systemically important financial institutions and public companies, but also companies seeking to sell securities in private placements exempt from registration under Regulation D. The Act modifies the net worth standard for an ‘accredited investor’ in a manner that should limit the number of individuals that qualify as accredited investors and requires the Securities and Exchange Commission to adopt rules restricting certain ‘bad actors’ from selling securities under Regulation D.
The changes were effective July 21, 2010, so companies raising capital in Regulation D offerings should ensure that their subscription and disclosure documents accurately reflect the changes, and that individual investors purchasing securities based on an exemption that relies on accredited investor status meet the revised standards. Failure to comply could result in the loss of the exemption.
How does Regulation D work, and how does the Act alter the accredited investor standard?
Regulation D provides a safe harbor for the issuance of securities in a private placement exempt from registration under the Securities Act. Companies making offers to accredited investors are subject to less rigorous requirements regarding the number of purchasers and required disclosures.
For example, under Rule 506 of Regulation D, sales may be made to an unlimited number of accredited investors and as many as 35 financially sophisticated nonaccredited investors, but the nonaccredited investors must be provided substantial disclosures. Regulation D sets forth categories of accredited investors who are deemed not to need the protections afforded by Securities Act registration.
Accredited investors include any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1 million. In the past, the SEC took the position that the fair market value of an investor’s primary residence could be included in the individual’s net worth. Section 413 of the Act changes the net worth standard for an individual accredited investor to specifically exclude the value of the individual’s primary residence.
The SEC has published new guidance to reflect change mandated by the Act. In addition, the SEC indicated that the related amount of any mortgage or other indebtedness secured by an investor’s primary residence also may be excluded up to the residence’s fair market value, but indebtedness secured by the residence in excess of the value should be considered a liability and deducted from net worth.
