August 4, 2010
The new standard excludes personal residences from the net worth test of an accredited investor. There has been some discussion in the media about the effect of mortgages on a personal residence and the corporate finance department stated as follows in CDI 179.01 and 255.47
The new CDI reads:
Question: Under Section 413(a) of the Dodd-Frank Act, the net worth standard for an accredited investor, as set forth in Securities Act Rules 215 and 501(a)(5), is adjusted to delete from the calculation of net worth the "value of the primary residence" of the investor. How should the "value of the primary residence" be determined for purposes of calculating an investor's net worth?
Answer: 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]
This interpretation does not clarify indebtedness that may have been invested in another asset class and whether that must be excluded as part of net worth. An example would be a second trust taken out 5 years ago and invested in a vacation home that has appreciated in value. We suggest that the correct answer is that the second trust must be excluded from the value of the second home or whatever asset was purchased. But this may not be necessary under the CDI and legislation and may be difficult to calculate. The staff should provide clear guidance on whether such debt must always be offset since its not offset if spent other ways. In other words if you squander it there is no deduction under the CDI for the related amount of indebtedness secured by the primary residence up to its fair market value. But if you invest it wisely there may be? Such a reading would seem to penalize the investor unfairly.