In a comment letter to the SEC, the North American Securities Administrators Association (NASAA) has urged the Commission to adopt an "investments owned" test for accredited investors in private offerings conducted under federal Regulation D. Writing to the SEC on November 4, 2010, NASAA President David Massey reiterated NASAA's belief that the quantitative standard contained in the current definition of "accredited investor" bears little correlation, if any, with an investor's qualifications for investing in securities offerings that do not benefit from the protections afforded by the registration process. NASAA supports, therefore, rulemaking efforts by the SEC that would adjust the accredited investor definition for inflation and exclude the primary residence from the calculation of an investor's net worth.
NASAA believes, however, that even these adjusted standards do not lend themselves to a presumption that an investor has the necessary decision making experience to invest in a private offering. In NASAA's view, an "investments owned" test provides a better quantitative standard because it is a more appropriate presumption that investors who have amassed a significant amount of investments may have sufficient decision making experience as compared to an investor who has a high net worth or income but may have little or no investment experience. Accordingly, NASAA has urged the SEC to adopt a test requiring that, in addition to satisfying the current income requirements for natural persons, the investor must have at least $1,000,000 in investments to qualify as an accredited investor.
NASAA also urged the SEC to clarify the recent staff interpretation concerning the exclusion of the value of an investor's primary residence from the calculation of the investor's net worth, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). NASAA noted that the SEC staff has issued guidance in recent Compliance and Disclosure Interpretations (Questions 179.01 and 255.47) stating that the indebtedness secured by the primary residence may also be excluded, up to the value of the residence. NASAA expressed concern that unscrupulous brokers may encourage investors who have a significant amount of equity in a home to take out a mortgage against that residence in order to manipulate their status under the accredited investor test and invest the proceeds in otherwise unsuitable private placement securities.
NASAA suggested, therefore, that the SEC clarify that the exclusion of debt secured by an individual's primary residence does not extend to debt incurred in order to invest in securities. Moreover, NASAA believes that the SEC should encourage the staff to provide guidance to issuers and broker-dealers that subscription agreements should include questions which require investors to acknowledge that they have not incurred any indebtedness secured by their primary residence in order to invest in the securities offered.
Finally, NASAA recommended that the SEC adjust the net worth standard for "qualified clients" contained in Rule 205-3 under the Investment Advisers Act of 1940 in order to parallel the exclusion of an investor's primary residence from the accredited investor definition. NASAA observed the "qualified client" test allows qualified clients of an investment adviser to enter into performance-based fee arrangements with their advisers. Moreover, these performance based fees are often collected from investors who invest in pooled investment vehicles in private offerings conducted under Rule 506 of Regulation D.
NASAA reminded the SEC that, although the qualified client test has been a more stringent than that for accredited investors, the Dodd-Frank Act did not mandate the adjustment of this net worth test to exclude the value of a client's primary residence. Accordingly, a failure to adjust the qualified client definition may create the curious result that an investor may qualify as a qualified client but not as an accredited investor, depending on the value of the investor's primary residence. As NASAA believes that the value of an individual's primary residence does not indicate an individual's level of investment sophistication, NASAA urged the SEC to commence rulemaking to adjust the qualified client definition under Rule 205-3 in order to exclude the value of a client's primary residence from the net worth test.