The Securities and Exchange Commission has offered up additional guidance on how hedge funds, venture capitalists, and start-ups should verify accredited investor status when they advertise private securities offerings.
In July 2013, the SEC amended Rule 506 of Regulation D to allow general solicitation of private offerings. The SEC amendments, however, permit advertising and marketing only if issuers “take reasonable steps to verify” that all of the purchasers are accredited investors, with a verifiable a net worth of at least $1 million in liquid assets. An issuer soliciting new investors through a publicly available Web site, social media, newspaper ads, or even billboards and infomercials, would be obligated to take greater measures to verify accredited investor status and ensure that investors are informed of potential risks and can withstand resulting losses.
Rather than dictate required verification steps, the SEC chose a “flexible, principles-based” approach and a non-exclusive list of verification methods that issuers may use, but are not required to use. Six new Compliance and Disclosure Interpretations issued by the Division of Corporation Finance, address questions and concerns that have been raised about these methods and the safe harbor protections they provide.
If a purchaser's annual income is not reported in U.S. dollars, what exchange rate should an issuer use to determine whether the purchaser's income meets the income test for qualifying as an accredited investor? The SEC's answer is that the issuer may use either the exchange rate that is in effect on the last day of the year for which income is being determined or the average exchange rate for that year.
The Commission also clarified that assets in an account or property held jointly with a person who is not the purchaser's spouse, 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.
Among the non-exclusive methods for verifying that a purchaser is an accredited investor is reviewing Internal Revenue Service forms that report the purchaser's income for the "two most recent years." If an IRS form is not yet available for the recently completed year, can the issuer still rely on this verification method by reviewing forms for the two prior years that are available?
The verification safe harbor would not be available under these circumstances, the SEC says. However, the issuer could satisfy the verification requirement by reviewing the past IRS forms and obtaining written representations from the purchaser that detail income for the recently completed year and verify a reasonable expectation of reaching the requisite income level.
If an issuer has reason to question the claim to be an accredited investor after reviewing these documents, it must take additional verification measures.. For example, if the purchaser's income for the most recently completed year barely exceeded the threshold required, these procedures might not constitute sufficient verification and more diligence may be necessary.
The SEC also clarified that, when dealing with a purchaser who is not a U.S. taxpayer, an issuer cannot rely upon comparable tax forms from a foreign jurisdiction.
An issuer can verify that a purchaser is an accredited investor by reviewing documentation of the purchaser's assets and liabilities "dated within the prior three months." Tax assessments, which are one of the types of documentation listed in this provision of the rule, are often prepared annually. In this situation, the SEC says, an issuer would not be able to rely on this information.
“Although the safe harbor is not available, we believe that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the 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,” Corp Fin wrote. “For example, if the most recent tax assessment shows a value that, after deducting the purchaser's liabilities results in a net worth substantially in excess of $1 million, it may be sufficient verification that the purchaser has met the net worth test.”
Another verification method verification allows an issuer to review a consumer report from one of the "nationwide consumer reporting agencies" to determine the purchaser's liabilities. However, the new guidance says, a consumer report from a non-U.S. consumer reporting agency, even if it performs similar functions as its U.S. counterparts, would not be sufficient.