The Securities and Exchange Commission (SEC) has issued new rules in connection with Title II of the JOBS Act which removes the ban on general solicitation for securities offerings, provided that all investors are accredited. In regards to this, a reasonable steps verification process must be completed in order to verify the accredited status of each purchaser.
Old Accredited Investor Rules
Under the old proposal from the SEC which relied on an investor self-certification approach, companies had to ask basic diligence of investors in order to determine that they were accredited. However, essentially the company could rely on the questionnaire answers that investors provided in order to make a determination of accreditation. These Rules, while old, still are applicable to the traditional Rule 506(b) offering which do not allow for general solicitation. The Rules, however, no longer apply to the new Rule 506(c) offering which does allow for general solicitation.
New Accredited Investor Rules
Under the new Rules, in exchange for the ability to generally solicit and advertise their offering under Rule 506(c), companies can no longer rely simply on a questionnaire or self-certification in order to determine accredited investor status. Instead, they must take reasonable steps either using a principles-based method, which essentially a vague category that says that one can think about the facts and circumstances of the offering and investment to consider whether a purchaser is accredited or not, or a safe-harbor method. For obvious reasons, most people opt to perform safe harbor verifications where possible.
Safe Harbor Rules
There are three safe harbors that would give you assurance that you had properly conducted a reasonable verification of an investor’s accredited investor status:
Income – this involves a review of a person’s IRS documents including (1040, 1099, W-2, K-1) the last two most recent years, as well as a written certification from individual that they anticipate to continue obtaining the same income level to meet the qualification requirements.
Net Worth – the following documents/information must be reviewed and dated within the past three months. In addition,a written representation must be provided from the person that all of their liabilities have been disclosed.
Liabilities: this will include credit report
Assets: certificates of deposit, bank statements, appraisal reports and tax assessments issued by independent third parties, and brokerage statements and/or other statements of securities holdings
Pre-existing Accredited Investors – A prior Rule 506(b) investor of an issuer reinvesting in that same issuer under a new Rule 506(c) offering.
Third Party Verification – written confirmation from one or more of the following that within the last three months they have had verified accredited investor status
* Registered investment advisor
* Registered broker-dealer
* CPA or licensed attorney
Reasonable Belief for Third-Party Verification
An issuer is permitted to depend on a third party that has verified an individual’s accredited investor status, as long as the issuer has a reasonable basis upon which to depend on the third-party verification.
Through the reasonable steps verification process, the issuer will meet their compliance obligations under the federal law. Failure to properly verify can have disastrous effects, but luckily compliance is reasonably easy.
