The Securities and Exchange Commission (the “SEC”) recently published six new Compliance and Disclosure Interpretations (“C&DIs”) related to the verification process for accredited investors under Rule 506(c) of Regulation D. The C&DIs indicate that the SEC is strictly construing the income and net worth safe harbors for verification of a purchaser’s status as an accredited investor.
The SEC adopted Rule 506(c) on July 10, 2013 as part of a set of new rules that lifted the ban on general solicitation and advertising in connection with certain private securities offerings. Rule 506(c) permits an issuer to use general solicitation and advertising to offer and sell securities so long as (i) all of the purchasers of the securities are accredited investors and (ii) the issuer takes “reasonable steps” to verify that the purchasers are accredited investors.
Rule 506(c) includes a list of four safe harbors for issuers attempting to verify that a purchaser is an accredited investor. The safe harbors include: (i) using Internal Revenue Service (“IRS”) records to verify purchaser income for the two most recent years and a written representation from the purchaser concerning expected income in the current year; (ii) reviewing documentation of purchaser assets and liabilities that is dated within the prior three months; (iii) obtaining written confirmation from a third party, such as a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant, of their verification of accredited investor status within the past three months; and (iv) obtaining a certification from a previous investor who qualified as an accredited investor prior to Rule 506(c)’s adoption, certifying that such person remains an accredited investor. In addition, instead of the safe harbors, issuers may use a principles-based method to verify an investor’s status as an accredited investor whereby the verification steps would vary based upon the particular facts and circumstances.
The newly published C&DIs provide the following guidance on the accredited investor verification process:
- A purchaser’s annual income that is not reported in United States dollars may be converted to United States dollars by either using the exchange rate in effect on the last day of the applicable year or the average exchange rate for that year (C&DI 255.48).
- Jointly held assets can be used to calculate a purchaser’s net worth, but only to the extent of such purchaser’s proportional ownership of the jointly held assets (C&DI 255.49).
- The safe harbor for reviewing IRS records is not available if a purchaser’s IRS form for the most recently completed year is unavailable (C&DI 260.35).
- The safe harbor for reviewing IRS records is not available where a purchaser is not a United States taxpayer and only has tax forms from a foreign jurisdiction (C&DI 260.36).
- The safe harbor for reviewing documentation of a purchaser’s assets and liabilities is not available for reliance on a tax assessment that is prepared only on an annual basis if the tax assessment is more than three months old (C&DI 260.37).
- The safe harbor for reviewing documentation of a purchaser’s assets and liabilities is not available for reliance on a consumer report from a non-U.S. consumer reporting agency (C&DI 260.38).
Although the C&DIs referenced in the final four bullets points above limit the availability of the income and net worth safe harbors for verifying a purchaser’s status as an accredited investor, the C&DIs state that issuers are not precluded from reasonably finding under the principles-based verification method that a purchaser is an accredited investor based in part on such information. Issuers presented with one of these scenarios that verify a purchaser’s status as an accredited investor using the principles-based verification method should review the C&DIs for further guidance from the SEC concerning additional steps that may need to be taken.
The C&DIs are available here. For additional guidance concerning the recent amendments to private securities offerings under Regulation D, please see our July 16, 2013 alert, “Rule 506 Revolution: The SEC Adopts Significant Amendments to the Rules Regarding Private Offerings of Securities” available here.