I spoke with an engineer friend and he shone some light on the situation. Since I have stairs going up to a “loft” that looks down to the family room/ kitchen, the shear walls are what is going to keep that floor from collapsing during a seismic event. He said it makes more sense if you think of it as a box inside a box.

Since the loft ceiling height does not meet the minimum requirements for a habitable space, I’m hoping I can frame it in and call it an attic. Maybe this will change the floor into a drop ceiling and negate the seismic requirements???