The North American Securities Administrators Association (NASAA) recently had some interesting comment to the SEC on the "Accredited Investor" standard for private placement investors under federal Regulation D and also on the less well known "Qualified Client" Test under the federal Investment Advisers Act.
Accredited Investors
An Investments Owned Test.
NASAA argues quite sensibly that just being high income or having a net worth of $1M including assets held jointly with a spouse (ex an investor's home value) does not mean an individual investor has the necessary decision making capability to assess the wisdom of investing in a private placement. NASAA suggests that a better qualification would be to require the potential investor to own $1,000,000 in investments.
Treatment of Mortgages on an Investor's Home
While an investor's home (the term used in Regulation D is "primary residence") is not counted in the plus column, the mortgage on the home (up to the value of the home) is not in the minus column in the detertmination of net worth. NASAA is concerned that some "unscrupulous" brokers might encourage persons with significant home equity to take out a mortgage against the equity to "manipulate" their status vis-a-vis the "Accredited Investor" test and invest the proceeds in an "otherwise usuitable" private placement. NASAA urges the SEC to clarify that the exclusion of debt secured by an indvidual's home does not extend to debt incurred to invest in securities. Also NASAA is asking the SEC to "provide guidance" to issuers and broker-dealer that subscription agreements should include questions that require investors to acknowledge that they have not inucrred any debt secured by their home to invest in the securities offered.
Qualified Clients
There is a somewhat less well known SEC Rule (Rule 205-3 under the Investment Advisers Act of 1940) that sets up a standard for a "qualified client". The "qualified client" standard generally needs to be met if an adviser is going to charge a client a performance fee - these fees (often referred to as "carried interests") are extremely common in the hedge fund and private equity fund worlds.
For individual investors one of the standards for being a "qualifed client" is having a net worth of $1.5 million alone or jointly with the investor's spouse (the "net worth" test) , including the value of the investor's home. NASAA found it anamalous that, while this value was excluded from the "Accredited Investor" standard, it was included in the seemingly higher threshold Qualifed Client test. Accordingly, NASAA has suggested to the SEC to commence rule making under Rule 205-3 to exclude the value of the investor's home from counting toward net worth under the net worth test. Perhap it would be good to add in an "investments owned" test here as well.
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Robert Kiggins, Esq. of McCarthy Fingar LLP, is author of the blog, and may be reached at (914) 385-1024 or rkiggins@mccarthyfingar.com.
Nothing is this blog is intended to or may be relied upon as specific legal advice. Securities and related laws are complex and competent counsel should be consulted
