Many of the provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act
merely provide for future regulatory framework. That it is in part true for the
changing definition of "accredited investor" under the Securities Act. The
other part is that the definition changed once President Obama signed the bill into law ten days ago.
The definition of accredited investor now excludes the
value of the primary residence from the calculation of net worth. Angel
investors who poured too much of their wealth into a new swimming pool and
cabana may get excluded from future private placements.
The SEC has also shown that it intends to be aggressive
in setting the new accredited investor definition through the rule-making
called for in Section 413 of Dodd-Frank. Last week, as part of their regular
Compliance and Disclosure Interpretations the SEC gave an opinion on valuing
the primary residence.
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. [July 23, 2010]
So you get no benefit to your net worth calculation for
your home. Even worse, if you are underwater on your home then that excess debt
is eating into your net worth calculation.
I think it's easy to argue with this interpretation. By
excluding "value" you can argue that it should exclude positive value as well
as negative value. You could also argue that in some states (and some loan
documents) the mortgage is non-recourse so the excess of debt over the value of
the home should be excluded.
You can make those arguments when the SEC begins its
rule-making to create a new definition for "accredited investor." For now, you
need to live by this interpretation while you are privately raising capital.
I expect the SEC is going to continue to be aggressive in
establishing the new standards. As I said early this month:
Looking into my crystal ball, I expect the SEC to adjust
the income standards based on inflation. That would put them at around $459,000
if single and $688,000 if married. I would also expect the standard to include
some sort investment expertise and knowledge standard. Having a big pile of
cash or a big paycheck will likely no longer be the only standard. At least that's my guess.
Now you will need a bigger pile of cash if your home
mortgage is underwater.
For additional commentary on developments in
compliance and ethics, visit Compliance Building, a blog hosted by Doug Cornelius.