“Net worth” is an important term in the financial world, as it helps firms make suitability determinations when clients are engaging in transactions in various investment products. But what does it really
mean? It depends.
Those of us with any kind of accounting experience know net worth as what is left over after
subtracting what you owe (your liabilities) from what you own (your assets). This might be called accounting net worth.
In terms of the securities industry, net worth takes other forms and is calculated differently. The following discusses some of these alternative measures of net worth:
Liquid Net Worth – In reviewing whether or not a person is suitable to make investments in many long-term or illiquid securities, such as UITs, REITs, and annuities, firms must look at a person’s liquid net worth. So what exactly is liquid net worth? Basically, it is that portion of a person’s net worth that can easily be converted to cash, which includes cash on hand or in the bank and investments, such
as stock or mutual funds. It does not include assets such as a person’s house, other real estate, or investments that have no ready market or that would involve significant penalties to liquidate. A home mortgage or loans on investments would be considered liabilities when calculating this amount. Therefore, liquid net worth is generally significantly lower than accounting net worth.
“Accredited Investor” Net Worth – Net worth is one consideration that may be evaluated in determining whether a potential investor is considered “accredited." One way a person can qualify as
an accredited investor under Regulation D is to, individually or jointly with a spouse, have at least $1,000,000 in net worth. Regulation D of the Securities Act of 1933 (“Reg. D”) sets forth the standard for the calculation of net worth. The calculation of net worth in determining an investor’s accredited status used to look very similar to the calculation of accounting net worth; however, the calculation has recently changed, as a result of standards set forth in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
Effective 60 days after the rule change is published in the Federal Register, the new standard for this net worth calculation will not include the value of a primary residence in a person’s assets and the indebtedness secured by this residence, up to its fair market value, is excluded from the person’s liability unless the indebtedness was incurred within the 60 days preceding the purchase of securities where accredited status is required.
Basically, the calculation will now look something like this, assuming the primary residence is valued at $250,000 and the indebtedness is $100,000 and is more than 60 days old:
| Net worth including residence and mortgage |
$2,000,000 |
| Less primary residence |
250,000 |
| Plus mortgage on primary residence |
100,000 |
| Net worth for accredited status |
$1,850,000 |
With individuals for whom most of their net worth is attributable to their primary residence, this rule change may mean they will not qualify for accredited status and they will be prohibited from investing in certain exempt securities. However, if individuals were accredited under the former standards, they would still maintain their accredited status for any follow-on investments, but they would need to qualify under the new standard for any new, unrelated investments.
This standard may be changed again in the future, since the Dodd-Frank Act requires the SEC to examine the definition of accredited investors again in 2014 and every four years thereafter.
Regulatory Compliance is committed to keeping our clients apprised of regulatory changes and helping them determine the impact of these changes on their firm. For more information about the changes to the accredited investor definition or calculating net worth, please contact your Compliance Partners account manager at 603-434-3594.
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