New Accredited Investor Verification Under 506(c) of Regulation D

Reasonable Steps to Verify Accredited Investor Status. Rule 506(c) of Regulation D as adopted contains both a general requirement that issuers take "reasonable steps" to verify that purchasers are accredited investors, as well as a non-exclusive list of methods that can be used to satisfy this requirement. As originally proposed, Rule 506(c) of Regulation D did not mandate a particular verification process or even identify a set of "safe harbor" procedures that would be deemed to be "reasonable." Instead, the proposing release identified certain factors that issuers would need to consider in determining whether their verification process is "reasonable." In the release adopting the final rules, the SEC retained the "principles-based" method of determining whether the verification steps taken by an issuer were reasonable, but supplemented it with four specific verification methods that will be deemed to constitute "reasonable steps" to verify a purchaser's status unless the issuer or its agent has knowledge that the particular purchaser is not an accredited investor. Under the "principles-based" method, the extent to which an issuer needs to verify the accredited investor status of a proposed purchaser is to be determined based on the facts and circumstances of the particular purchaser and transaction. The adopting release identifies the following as among the factors that an issuer should consider in determining whether the verification steps taken in any particular case were "reasonable."

  • Nature of the Purchaser. Reasonable verification steps would differ depending on the category of accredited investor in which the purchaser falls. For example, relatively little verification would be required where the purchaser is an accredited investor by virtue of its being a registered broker-dealer. By contrast, more extensive verification would be required for natural persons, whose accredited investor status is based on either income or net worth.
  • Information about the Purchaser. Issuers could review or rely on the following types of information, which depending on the circumstances may or may not be sufficient verification in and of themselves:
  • Publicly available information in regulatory filings, such as an executive's compensation as reported in his/her employer's proxy statement filed with the SEC, or a tax-exempt organization's assets as reported in its Form 990 filed with the IRS.
  • Third-party information that is reasonably reliable, such as an individual's pay stubs or publicly available information about the average compensation earned at the purchaser's workplace by persons at his or her position.
  • Verification of the person's status as an accredited investor by a third party if the issuer has a reasonable basis for relying on this source. The release anticipates that in the future vendors may emerge to fulfill this function.
  • Nature of the Offering. An issuer that solicits purchasers through media accessible by the general public or by widely disseminated email or social media solicitations would need to take greater measures to verify accredited investor status than an issuer that limits its solicitations to pre-screened investors. Where the solicitation is made available to the general public, purchaser questionnaires and self-certifications would be insufficient verification.
  • Terms of the Offering. If the minimum investment is sufficiently high that only accredited investors could reasonably be expected to invest that amount, the additional verification required would be limited. The release indicates that in this situation it may be sufficient for the issuer to verify that the investment is not being financed by the issuer or a third party.

The four verification methods that are deemed "reasonable" (absent knowledge to the contrary) all relate to the status of individuals, and are as follows:

  • Income. An issuer may verify an individual's status as an accredited investor on the basis of income by reviewing copies of any IRS form that reports net income, such as Forms W-2 or 1099 (which are typically filed by an employer or other third party payor), or Forms 1040 filed by the prospective purchaser (with non-relevant information permitted to be redacted). Under this method, the issuer must review IRS forms for the two most recent years and obtain a written representation from the prospective purchaser that he or she has a reasonable expectation of attaining the necessary income level for the current year. Where accredited investor status is based on joint income with the person's spouse, the IRS forms and representation must be provided with respect to both the purchaser and the spouse.
  • Net Worth. Under this method, an issuer would need to review bank or brokerage statements or third-party appraisal reports to verify the purchaser's assets and a credit report to verify liabilities, in each case dated within the prior three months, and would need to obtain a written representation from the prospective purchaser that all liabilities have been disclosed. Where accredited investor status is based on joint net worth with the person's spouse, the asset and liability documentation and representation must be provided with respect to both the purchaser and the spouse.
  • Reliance on Determination by Specified Third Parties. An issuer is deemed to satisfy the verification requirement if the issuer obtains a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that within the prior three months such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor and has determined that the purchaser is an accredited investor. While these are the only categories of third parties that the issuer is entitled to rely on without further steps, the SEC release notes that in appropriate circumstances an issuer may be entitled to rely on a similar confirmation by a third party that is not in one of these categories if the issuer has a reasonable basis to rely on such verification.
  • Existing Accredited Investors. If a person purchased securities as an accredited investor in a previous Rule 506(b) offering by the issuer (i.e., made without general solicitation) and continues to hold such securities, the issuer may continue to treat such person as an accredited investor if it obtains a certification by the person at the time of the Rule 506(c) sale that he or she qualifies as an accredited investor. However, this method is only available if the previous Rule 506(b) offering was made before the effective date of Rule 506(c).

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POSTED BY: Chris Wilson
POSTED: 20th February 2014
FILED AS: Corporate Law, Jobs Act, Private Offerings