Private Funds & Advisers
On December 21, 2011, the SEC adopted a final rule amending the net worth standard for accredited investors. Although the new net worth test took effect on July 21, 2010 – the day the Dodd-Frank Act was enacted – the revisions conform SEC rules to the new standard. Among other things, the final rule affects an investor’s eligibility to invest in private funds.
The amended standard eliminates the value of a person’s primary residence from the $1 million minimum net worth threshold. In most instances corresponding mortgage debt will also be excluded from the calculation. However, to prevent an artificial increase in net worth, mortgage debt will be treated as a liability in certain circumstances, including:
- increases in mortgage debt on the primary residence within 60 days of the sale of the securities; and
- mortgage debt over and above the value of the primary residence.
The final rule also includes a very limited grandfathering provision available for certain follow-on investments if the investor has a pre-existing right to purchase the investment, such as an option or warrant. Effectively, an existing investor in a private fund who no longer meets the definition of accredited investor may be excluded from reinvesting in the fund if such investor has no pre-existing right to purchase shares of the fund, which may be provided in a side letter.
Dodd-Frank also requires the SEC to review the definition of “accredited investor” every four years, beginning in 2014, and adopt new rules where appropriate.
The new rules are effective on February 27, 2012.
In a related move, on July 12, 2011, the SEC issued an order adjusting the dollar amount thresholds in the definition of qualified client for performance fee purposes. Effective September 19, 2011, to be a qualified client, individuals must either have:
- assets under management of $1 million after the investment; or
- net worth of $2 million at the time of the investment.
The SEC also proposed transition rules allowing advisers to maintain existing performance fee arrangements where the investor met the qualified client standard when the contract was entered into, even if the investor is not a qualified client under the new standards. These proposed rules, however, have not yet been adopted.