The JOBS Act and the Capital Raising Process (Crowdfunding and the Computation of Net Worth)
We noted that the crowdfunding exemption is premised around reduced protections for investors, but restrictions on the amount they can invest. The idea is that crowdfunding is not unlike gambling, but the stakes allowed to be wager are low.
This is simply not true. The test for investment limits looks to income and net worth. If below $100,000, the amount that can be invested is the greater of $2,000 or 5%. If above $100,000, the amount is 10%. The key is net worth. The JOBS Act provides that net worth is to be calculated in the same fashion as the test for accredited investors (accredited investors are those with a net worth of $1 million or more).
The term net worth is not defined in Regulation D. The SEC has merely characterized it as the difference between assets and liabilities. See Securities Act Release No. 9177 (Jan. 25, 2011) ("Neither the Securities Act nor our rules promulgated under the Securities Act define the term 'net worth.' The conventional or commonly understood meaning of the term is the difference between the value of a person's assets and the value of the person's liabilities.").
Moreover, the SEC has indicated that no assets are excluded from the calculation. See Securities Act Release No. 6455 (March 3, 1983) ("Rule 501(a)(6) does not exclude any of the purchaser's assets from the net worth needed to qualify as an accredited investor."). Indeed, the Commission adopted a higher net worth threshold in Regulation D in order to avoid having to decide what assets, if any, should be excluded from the calculation. See Securities Act Release No. 6389 (March 8, 1982) ("Some commentators, however, recommended excluding certain assets such as principal residences and automobiles from the computation of net worth. For simplicity, the Commission has determined that it is appropriate to increase the level to $1,000,000 without exclusions.").
This lack of any exclusion was modified by Congress in Dodd-Frank. Congress required the Commission to exclude from net assets the value of the primary residence. This has been done. See Rule 501(a)(5) of Regulation D. But that is it. No other assets are explicitly excluded.
All of this suggests that in calculating net worth, individual investors are allowed to consider assets in retirement accounts. We have not found any explicit pronouncements on this issue by the Commission. Nonetheless, there are other instances where parties included retirement accounts in the net worth calculation without controversy. See In re Desano, Initial Decisions Release No. 412 (admin proc. Jan. 18, 2011) ("Burns, representing that he has been unemployed for almost six years and has a net worth of $260,000, including retirement accounts and the blue book value of his car, claims an inability to pay, but has not provided a sworn financial statement."); see also In re Prime Capital Services, Inc., Exchange Act Release No. 61719 (admin proc March 16, 2010) ("In 2004 and 2005, Representative Wells induced a 71-year-old woman to liquidate her retirement account and invest all of her retirement savings -- which was more than half her net worth -- in variable annuities.").
This suggests that individuals with very modest income levels will be able to nonetheless invest in crowdfunding ventures sums equal to 10% of their net worth, including retirement plans. Thus, an individual with $300,000 in an IRA and an income of $30,000 will be allowed to invest his or her entire income (10% of net worth or $30,000) in a crowdfunding venture. Moreover, for those engaging in fraudulent deals will have an incentive to focus on retirees who have a modest amount tucked away in retirement accounts in order to take advantage of the net worth forumula.
Whatever the theory of crowdfunding, the amount allowed to be gambled can be significant. If this were Las Vegas, it would be necessary to move crowdfunding to the high stakes part of the casino.