SEC Does Right Thing, Shows Sensitivity to Angel Financing

UPDATE Jan. 28: I'm reading the release a second time and think now my "underwater mortgage" conclusion below is mistaken. By some of the examples given in the release, it appears the intention of the SEC is to say that, yes, to the extent a mortgage liability exceeds the equity value of the principal residence secured, that excess "dings" your net worth; so the principal residence isn't simply taken off the table altogether. Because the proposed rule is not as clear as the prior SEC guidance, I do think that, in a nonrecourse jurisdiction, one could reasonably determine that a mortgage liability in excess of value may be no actual liability at all, and in that way have zero impact on net worth. The best thing, IMHO, would be to simply take the principal residence off the table, as that would be an easier rule for all to understand and to self-police.

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My gut told me that the SEC was not going to jack up the annual income thresholds for the accredited investor definition, in spite of wiser heads assuming that it would, and NASAA advocating it take Dodd-Frank implementation as an excuse to do so.

Well, the Commission left well enough alone.

What's more, they listened to the better argument on the ambiguity Dodd-Frank left us as to how to deal with underwater mortgages. So when you exclude the value of the principal residence from your net worth, for purposes of measuring the $1 million threshold, you exclude all positive value, but you don't "ding" yourself for negative value. In other words, if your principal residence is a net liability, and not an asset at all, you simply ignore it for purposes of the $1 million net worth threshold.

At least that is what the rule proposed yesterday states. I suppose its conceivable that some will argue over the course of the rulemaking process to make it less angel financing friendly.

But I doubt the SEC will go for that.

I see "signaling" in language in an SEC press release, a suggestion that the Commission means to leave the definition alone for four years:

"The new net worth standard must remain in effect until July 21, 2014, four years after enactment of the Dodd-Frank Act.  Beginning in 2014, the Commission is required to review the definition of the term 'accredited investor' in its entirety every four years and engage in further rulemaking to the extent it deems appropriate."

Now, as a technical matter, the four year moratorium on messing with the accredited investor definition technically only applies to the net worth definition. Arguably, the SEC remains free to reconsider the income thresholds at any time. So I think the language quoted above is significant, a soft indication that the SEC will not exploit its arguable discretion to act earlier on the annual income tests.

Lest it start to sound like I am engaging in rank partisan rent seeking for angel investors, let's all be reminded that most startups are angel backed, that even the few that secure VC funding likely first receive seed money from angels, and that experience suggests that the current thresholds for accreditation -- which in real terms move lower over time, at least in years where there is inflation -- remain appropriate and safe.

I think the ACA and other angel groups really did the startup ecosystem a great turn last year in advocating and educating legislators and the SEC about what angel capital is, and how startup and entrepreneurial activity is dependent on angel financing.

Tomorrow morning on this blog: Just How Many Angels Will the SEC's Proposed Rule Spare?


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