Certain private placements and limited offerings may be made without registration, and without requiring specified disclosures, if sales are made only to “accredited investors.” One way individuals may qualify as accredited investors is by having a net worth, alone or together with their spouse, of at least $1 million. The Securities and Exchange Commission recently amended its rules to exclude the value of a person’s home from net worth calculations used to determine whether an individual falls under the definition of an accredited investor. This change aligns the SEC’s definition with the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
The rule changes also affect how loans secured by a primary residence are treated. Under the amended net worth calculation, indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence, is not treated as 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. (In other words, a standard first mortgage for purchase of a primary residence is not counted as a liability.) This is intended to prevent the artificial inflation of net worth by borrowing against home equity shortly before participating in an exempt securities offering. In addition, any indebtedness secured by a person’s primary residence in excess of the property’s estimated fair market value is treated as a liability under the new definition. This will affect all those who are currently upside down on their homes.
This rule change does not affect the definition of “high net worth individuals” for purposes of your ADV 1 filings, however. In the ADV instructions, the SEC states: “The Form ADV Glossary of Terms explains that a “high net worth individual” is an individual with at least $750,000 managed by you, or whose net worth your firm reasonably believes exceeds $1,500,000, or who is a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940. The net worth of an individual may include assets held jointly with his or her spouse.”
In our view, this change in calculation of net worth for determining whether someone is an accredited investor is a positive change, but one that is too late in coming for some investors. One example is a couple whose legal case we consulted on in Florida a few years ago. Both were retired from middle/working class professions, and neither was a sophisticated investor. The registered representative they worked with relied on the high value of their home in New England that they were trying to sell, plus the value of their recently purchased retirement home in Florida, to “qualify” them as accredited investors. He sold them a private placement they did not understand, and that subsequently blew up. The broker-dealer went out of business and, in the end, the couple lost half of their retirement due to one unsuitable recommendation. Had this new definition been in place, their lives would be much different today.
Mary Harris-King and Paul King, CSCP®