Best Practices For Verifying Accredited Investors
The recent passage of the Rule 506(c) Exemption from Registration with the Securities and Exchange Commission (“SEC”) brought with it a deviation from the general ban against general solicitation in the offer and sale of a security standards. However, this is a departure from the general solicitation ban and can leave one wondering how does an issuer of a security relying on the Rule 506(c) exemption verify accredited investor status?
An accredited investor is defined as an individual who has an annual income of over $200,000 (or $300,000 of joint annual income) and a personal net worth in excess of $1,000,000.
Rule 506(c) has provided some guidance with the issuance of a “Safe Harbor” verification method Under Rule 506(c)(2)(ii)(A):
“When verifying a purchaser under the accredited investor annual income test, reviewing any Internal Revenue Service (IRS) form reporting a purchaser’s income for the two most recent fiscal years and obtaining a written purchaser representation that he or she has reasonable expectation of reaching the required income level during the current fiscal year.”
In addition, under Rule 506(c)(2)(ii)(B):
“When verifying a purchaser under the accredited investor net worth test, reviewing specified documentation evidencing the purchaser’s assets and liabilities dated within the prior three months and obtaining a written purchaser representation that all liabilities necessary to make a determination of net worth have been disclosed.”
Questions of Accredited Investor Status
The guidance provided by SEC in Rule 506 is quite clear. However, how does an issuer respond when the issuer has reasonable grounds to question whether the prospective purchaser has attained accredited investor status? Under the Safe Harbor rules, the issuer must take additional steps in order to verify that the prospective purchaser is an accredited investor.
As an issuer, how should you ensure that your prospective purchaser is an accredited investor? As a general rule, the following should be part of your verification procedures:
- Individual (or joint) income tax return for the previous three years
- Personal (or joint) financial statement
- Disclosure of present business holdings
- Signed Purchaser Representation Statement that the purchaser believes they qualify as an accredited investor
This is not an exhaustive list, and an issuer may need additional information in order to verify accredited investor status, based upon the particular facts and circumstances of the individual prospective purchaser.
There may be severe consequences for selling an unregistered security to a non-accredited investor when the security does not qualify as exempt from registration under Rule 506(c) (or any other exemption). It is important to follow accepted practices and principles of Securities Regulation when it comes to issuing an unregistered security.
If you have more questions about the issuance of unregistered securities under Rule 506(c), or you have legal questions regarding Securities Regulation in general, please contact our office at (513) 241-0400. You can also fill out the contact form on our website and one of our attorneys will respond shortly.