We recently published a Business Alert regarding the SEC’s adoption of the final rule to lift the ban on general solicitation and advertising in Rule 506 offerings to accredited investors. The new rule goes into effect in approximately 60 days. This article focuses on the accredited investor verification requirements which are central to permitted general solicitation and advertising in connection with Rule 506(c) offering of securities.
The prior Rule 506 accredited investor requirement remains as Rule 506(b) and requires that the issuer form a reasonable belief as to the status of the accredited investors in a traditional private placement that does not involve general solicitation. However, in order to take advantage of the general solicitation and advertising provisions of the new Rule, the issuer must take reasonable steps to verify that all the purchasers of the securities are accredited investors.
The SEC Release indicates that whether the steps taken to verify accredited investor status are reasonable will be an objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction. The SEC also included a list of specific and detailed non-exclusive, non-mandatory methods for verifying accredited investor status of purchasers who are natural persons. Although these “suggested methods” are not mandatory, issuers should be careful to include measures that are designed around these suggested methods and target the levels of verification articulated in these examples. These new verification methods depart from traditional practice in that they require significantly more information from potential investors, much of which is personal and confidential. The SEC’s list includes:
- Satisfying the Income Requirement. Review tax forms, including W-2s, 1099s, K-1s, and 1040s, that report the purchaser’s income for the two most recent years. The SEC also asks for a written representation from the purchaser (and the purchaser’s spouse) that the purchaser has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year.
- Satisfying the Net Worth Requirement. Review bank, brokerage and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports. To ascertain liabilities obtain reports from credit agencies. The reports would need to be dated within the prior three months. Further, the issuer would need to obtain a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed.
- Third Party Confirmation. The issuer might (instead) ask for a written confirmation from certain third parties, including broker-dealers, SEC-registered investment advisers, attorneys and certified public accountants, that such third party has taken reasonable steps within the prior three months to verify that the purchaser is an accredited investor based on either the income requirement or the net worth requirement.
- Grandfathering of Existing Investors. In follow-on rounds, the investors who purchased securities in a Rule 506 offering as an accredited investor prior to the effective date of the new Rule, could certify that they remain qualified as accredited investors.
The Release indicates that “if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party.”
These new verification methods will no doubt require investors to share their personal finances with the issuer. Although that may be acceptable to some investors, many will be reluctant to do so. Third party verification may help to facilitate this process offering both the issuer and the investor needed assurances. The issuer gains the assurance that it is satisfying the SEC’s heightened verification requirements, and the investors gain confidence that their personal financial information is appropriately protected. Whether these services become regularly available remains to be seen.