As we discussed here, using Rule 506(c) under Regulation D has some significant advantages, the most important of which are the ability to engage in general solicitation and advertising and the non-requirement that the investors have a preexisting relationship with the officers, directors, employees, brokers, or representatives of the issuer.

However, precisely because some investors might be “strangers,” Rule 506(c) requires the issuing company to verify that all the investors are actually accredited investors.

Here is the quick rundown on verifying accredited investor status.

Only Reasonable Steps are Required

 First, it is important to note that regulations issued by the Securities & Exchange Commission (“SEC”) only require “reasonable steps.” In other words, no deep vetting and background checks are required.

Documentation/Proof Comes From the Potential Investor

Second, the documentation/proof comes from the potential investor. So, no active steps are needed by the issuing company.

Issuer can Rely on Investors Documentation/Proof

Third, the issuing company and its officers, directors, and representatives can rely on the potential investors documentation UNLESS the issuer has actual knowledge that such potential investor is not an accredited investor. So, avoid deep vetting and/or background checks.

What are Reasonable Steps to Verify?

The SEC has promulgated regulations that provide four non-exhaustive and non-mandatory methods of taking reasonable step to verify depending on how the potential investor is claiming to be an accredited investor. See 17 CFR 230.506. Note that these are “in the alternative” methods. That is, only one method need be used to verify status as an accredited investor.

“Reasonable steps” are:

• On the basis of income, reviewing IRS income reporting forms for the two most recent years (e.g., 1040s, W-2s, 1099s) AND obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the necessary income during the current year
• On the basis of net worth, reviewing documentation dated within the prior three months such as bank statements, brokerage statements, statements of securities holdings, certificates of deposit, tax assessments, appraisal reports issued by independent third parties with respect to assets; AND with respect to liabilities, reviewing a consumer report from at least one of the nationwide consumer reporting agencies AND obtaining a written representation from the purchaser that all liabilities have been disclosed:
• On the basis of third-party investigation, obtaining a written confirmation that such person or entity has taken reasonable steps within the last three months to verify that your potential investor/purchaser is an accredited investor from:

(1) A registered broker-dealer;

(2) An investment adviser registered with the SEC;

(3) A licensed attorney who is in good standing; or

(4) A certified public accountant who is duly registered and in good standing

• On the basis of recent history as a 506(b) purchaser, obtaining a certification from the potential investor that he or she still qualifies as an accredited investor for the issuer’s 506(c) offering where such person purchased securities in the same issuer’s Rule 506(b) offering prior to September 23, 2013, and continues to hold such securities.

Contact San Diego Corporate Law

For further information on Regulation D, accredited investors, and private securities offerings/sales, contact Michael J. Leonard, Esq., of San Diego Corporate Law by email or by calling (858) 483-9200.

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