Business

I've had several conversations with concerned entrepreneurs over the last year about changes in the accredited investor standards under the Dodd-Frank Act.  In January the SEC proposed amendments based on Dodd-Frank to the accredited investor standard which subtracts the net equity value of an investor’s primary residence from that investor’s net worth determination.

Example: Currently if an investor has $800k net equity before equity in primary residence and $300k in net equity in the primary residence, that person qualifies as an accredited investor as they meet at $1MM net worth threshold.  Under the new rules that same person does not qualify as the $300k is excluded from the calculation.

I disagree with this portion of Dodd-Frank and the SEC’s proposed amendments.  From an economic standpoint, entrepreneurs are under enough pressure as it is to raise capital in the troubled economy, and these changes to investor standards may be a final nail in the coffin for many of them.  The obvious result of the amendment is a lower pool of investors for early stage and smaller company entrepreneurs to approach regarding exempt offerings (the precise companies that must get funded for our economy to rebound).  Many private equity firms and angel investor groups are made up of these "barely accrediteds" who pool their money and due diligence abilities to invest in early stage companies.  This amendment will cause many of these funds and groups to either cease or become much less integral in the capital strategy world.

From an investor/capital economy/personal rights standpoint, legislators and the SEC should be encouraging private investment – not telling folks that they are no longer wealthy enough to make personal decisions on investment opportunities because too much of their investment portfolio is tied to their primary residence.  Historically this country has encouraged citizens to treat their primary residence as their #1 investment.  Now your personal residence is a hindrance on your ability to grow your investment portfolio.

To top it off, the SEC proposal has a serious loophole.  If you think about it, an investor can take out a second loan on the primary residence and count the cash proceeds of the loan towards a net worth determination.  This strikes at the heart of the SEC’s intent of the entire rule change.  It also encourages bad financial behavior from U.S. citizens who are riding the edge of being considered an accredited investor.

I know folks who have done this – borrowed against their house in order to buy securities issued under a private placement offering.  In the past that may have been looked at with disfavor by financial advisers.  Under the SEC’s proposed rules I think advisers will encourage the practice.  This is not an incentive they should be creating.