SEC Issues Additional Guidance on Verifying Accredited Investors For Regulation D Offerings
July 10, 2014
On July 3, 2014, the SEC issued new guidance in the form of Compliance and Disclosure Interpretations (“CD&I”) relating to verification of investors as “accredited” investors for purposes of Rule 506 of Regulation D. When the SEC expanded Rule 506 to permit general solicitations and general advertising in private offerings, it included a requirement in Rule 506(c) that an issuer must take reasonable steps to verify that purchasers are accredited investors. The CD&I clarify certain aspects of that verification process.
Background
Rule 506(c) includes a non-exclusive list of specific accredited investor verification methods, as follows:
Income. In verifying whether a natural person is accredited on the basis of income, an issuer will be deemed to satisfy the verification requirement by reviewing copies of IRS Forms W-2, Forms 1099, Schedules K-1, and a copy of filed Form 1040 for the two most recent years together with written representations about a person’s reasonable expectations of reaching the income levels required to satisfy accredited investor status based upon income or joint income with that person’s spouse. (Rule 506(c)(2)(ii)(A))
Net Worth. In verifying whether a natural person is accredited based on net worth, an issuer will be deemed to satisfy the verification requirement by reviewing one or more of the following types of documentation, dated within the past three months, and written representations that all liabilities necessary to make a determination of such status have been disclosed:
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Assets: bank statements, brokerage statements, certificates of deposit, tax assessments, and third party appraisal reports; and
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Liabilities: a credit report from at least one nationwide consumer reporting agency. (Rule 506(c)(2)(ii)(B)
Third Party Confirmation.
In addition, an issuer will be deemed to satisfy the verification requirements by obtaining a written confirmation from any one of the following third parties provided they have taken reasonable steps to verify that a purchaser is an accredited investor, namely:
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a registered broker-dealer;
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an SEC registered investment advisor;
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a licensed attorney; or
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a CPA. (Rule 506(c)(2)(ii)(C))
Additional SEC Guidance
The SEC guidance relating to the above verification methods covers the following topics:
Joint Property. In the event that assets are held in an account or property is held jointly with another person that is not a spouse, the staff has taken the position that the assets may be included in the calculation for the net worth test, but only to the extent of his or her percentage ownership of the account or property. (Question 255.49)
Tax Returns. Where tax returns for the “two most recent years” are not available, the verification method set forth in Rule 506(c)(2)(ii)(A) would not be available; however, the Staff has said that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement under the principles-based verification method by:
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reviewing the IRS forms that report income for the two years preceding the recently completed year; and
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obtaining written representations from the purchaser that (i) an IRS form that reports the purchaser’s income for the recently completed year is not available; (ii) specify the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor; and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year.
Non-U.S. Income or Taxpayer. If the purchaser’s annual income is not reported in U.S. dollars, the issuer may use either the exchange rate in effect on the last day of the year for which income is being determined or the average exchange rate for that year. (Question 255.48) In addition, where the purchaser is not a U.S. taxpayer and cannot provide an IRS form reporting income, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available; however, the Staff has said that an issuer could satisfy the verification requirement under a principles-based verification method by reviewing filed tax forms that report income where the foreign jurisdiction imposes penalties for falsely reporting information comparable to that imposed by the U.S. (Question 255.36)
Tax Assessments. Although tax assessments have been specifically listed under Rule 506(c)(2)(ii)(B) as documentation of an investor’s assets and liabilities, those documents must be “dated within the prior three months” in order for the safe harbor of Rule 506(c)(2)(ii)(B) to be available. However, the SEC believes that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy its verification requirement of Rule 506(c) under the principles-based verification method if it uses the most recently available tax assessment when determining whether the purchaser has the requisite net worth. (Question 255.37)
Consumer Reports. For purposes of the verification method set forth in Rule 506(c)(2)(ii)(B), a consumer report from a non-U.S. consumer reporting agency would not satisfy the requirements of the safe harbor; however, the SEC believes that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy its verification requirement of Rule 506(c) under the principles-based verification method by reviewing the report and taking any other steps necessary to determine the purchaser’s liabilities (such as a written representation from the purchaser that all liabilities have been disclosed).
In each case where an issuer is relying on documentation under a principles-based verification method, additional verification steps must be taken if the issuer has reason to question the reliability of the information.
For more information, please contact:
Neil R.E. Carr
Direct Dial: +1 202 587 2983
neil.carr@somertons.com
Kathleen L. Cerveny
Direct Dial: +1 202 779 9507
kathleen.cerveny@somertons.com
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