While proposed changes to the federal definition of an accredited investor seek to boost protection for investors participating in non-public offerings, financial advisors must approach the investments with vigilance, legal experts say.

Previous rules define an accredited investor as having a net worth of $1 million or more. But changes to the definition, in tandem with the Dodd-Frank Wall Street Reform and Consumer Protection Act, will exclude an investor's primary residence when tallying net worth.

The changes to the accredited investor definition were put into effect with Dodd-Frank last July. As a result, the U.S. Securities and Exchange Commission plans to revise existing rules including the Securities Act of 1933 and Form D, according to SEC documents. Regulation D rules allow for companies to conduct offerings without registering with the SEC, while submitting brief notice of transactions in a Form D filing.

The spotlight on the accredited investor definition comes as investments in non-public offerings by private companies, or private placements, have publicly soured because of certain cases. Alleged fraud or mismanagement at companies, including DBSI, Medical Capital Holdings and Provident Shale Royalties, led investors to lose all of the capital they invested. In April, FINRA continued its pursuit of those cases, sanctioning two firms and seven individuals for not investigating the private placements tied to Medical Capital and Provident Royalties before selling them.

"During the last three years of this Great Recession, when the tide went out, everyone who wasn't wearing a bathing suit was discovered, and there's been some really horrendous stories," says Nicholas J. Taldone, a Clearwater, Fla.-based investment attorney.

Taldone says he has witnessed cases from his eponymous law practice where investors have been misled or used, many times because of the accredited investor label. Besides not fully explaining an investment choice because of the accredited investor title, Taldone says he has seen other more egregious violations, including advisors falsifying records to bring a client to the accredited investor threshold.

"It's sort of like this golden aura around it that once someone's called an accredited investor, they're so sophisticated that they don't need to know everything," Taldone says. "That's my own personal opinion that I've seen bolstered anecdotally in cases that I've had."

Brokerage firms will likely step up their own diligence, Taldone says, after private placement mishaps sunk firms like GunnAllen Financial Inc., and QA3 Financial Corp. In the meantime, advisors can protect themselves by always keeping in mind full disclosure rules, he says.

Changing the definition of an accredited investor can only help financial advisors to include the right clients who can withstand the high risk and high return model of private placement investments, says Jane Stafford, a managing member at Kansas City, Mo.-based securities law firm Stafford & Associates LLC. "It needs to truly be money that this individual can afford to lose," Stafford says of the ideal accredited investor. "No one likes to lose money, but it would not be such that it would change the person's lifestyle. We talk about the proverbial grandmother in sneakers. That's who you don't want."

Many states already have rules limiting how much participants can invest in offerings, which Stafford says could be as much as 20% of their net worth. Other states fall under the category of so-called "merit states" because they evaluate the merits of the offerings. Those kinds of limits mitigate risks for an investor and ultimately the financial advisor, who can often be the only one left standing when fraud or company failure erupts, Stafford says.

Advisors may need to be more aware of the indebtedness a client may have in case fluctuations change their accredited investor status, says Ed Johnsen, a partner at New York law firm Winston & Strawn. Grandfathering protocol must also be established so that existing investors who no longer meet the accredited investor requirements can know if they can make reinvestments.

The debate surrounding the accredited investor definition will likely continue, as the Dodd-Frank legislation also authorizes the SEC to review the accredited investor definition every four years.

The U.S. Comptroller General has been ordered to complete a full study of financial thresholds for the accredited investor definition. That study is due three years from Dodd-Frank's enactment. An SEC spokeswoman declined to comment for this story.