Verifying Accredited Investors in Public Rule 506 Offerings: SIFMA Guidance

by Stinson Leonard Street - Dodd-Frank and the Jobs Act
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On June 23, 2014, the Securities Industry and Financial Markets Association (SIFMA) published a memo outlining several specific methods for verifying accredited investor status that SIFMA believes would satisfy the requirement, in a Rule 506(c) offering involving general solicitation, that the issuer take “reasonable steps” to verify the accredited investor status of each purchaser in the offering.

As a quick refresher (full summary of the rule here), Rule 506(c) allows issuers, for the first time since the advent of the securities laws, to publicly advertise private offerings of securities, provided that are number of requirements are met. Sales in a Rule 506(c) offering can only be made to accredited investors and the issuer must take “reasonable steps” to verify that each purchaser is in fact an accredited investor. This is in contrast to a traditional Rule 506 offering (now a Rule 506(b) offering) in which the issuer may rely on a representation from the purchaser that the purchaser is an accredited investor. In a Rule 506(b) offering, it is enough that the purchaser checks a box to indicate the purchaser is an accredited investor; the SEC has stated that, in a Rule 506(c) offering, relying on a purchaser to check a box is not enough to satisfy the “reasonable steps” requirement. The SEC has attempted to mitigate the uncertainty provided by the “reasonable steps” requirement by providing four safe-harbor verification methods for complying with the standard. However, the safe harbor methods outlined by the SEC may be of limited utility because three out of the four methods require natural persons to, for example, disclose sensitive personal financial information to the issuer or other third party such as a broker-dealer or lawyer.

SIFMA is attempting to bridge the gap by setting forth several specific methods that broker-dealers and investment advisers could use to verify the accredited investor status of individuals, as well as some examples aimed at verifying the accredited investor status of certain entities.   The memo contains an example questionnaire for use in verifying accredited investor status of natural persons and an example of a written verification that could be provided to an issuer by a broker-dealer, investment adviser, or law firm certifying that a purchaser is an accredited investor (which is one of the four SEC safe harbors).

I’ll summarize the methods outlined by SIFMA for verifying the accredited investor status of natural persons in a moment, but first, it’s worth putting the SIFMA guidance in context. This is not SEC guidance on satisfying the “reasonable steps” test, and there is no guarantee that complying with the methods described in the SIFMA memo would be deemed sufficient by the SEC. The memo only represents “examples of the types of methods that [SIFMA] believe[s] can constitute reasonable steps to verify in light of the facts and circumstances outlined [in the memo].” Having said that, these methods have been endorsed by SIFMA and 20 prominent law firms, and an issuer that relied upon the SIFMA guidance, in the absence of specific SEC guidance, would have a strong case that the issuer was taking “reasonable steps” to verify the accredited investor status of each purchaser in an offering.

For registered broker-dealers and investment advisers seeking to verify the accredited investor status of a natural person the SIFMA memo provides the Account Balance Method and the Investment Amount Method.

Account Balance Method:

  • The purchaser has been a client of the firm for at least six months;
  • The purchaser has, individually or with a spouse, unpledged marketable securities in excess of $2 million in accounts with the firm;
  • The purchaser has made representations regarding status as an accredited investor (by completing the questionnaire attached to the SIFMA memo); and
  • The firm is not aware of any facts that call the into question the status of the purchaser as an accredited investor.

Investment Amount Method:

  • The purchaser has been a client of the firm for at least six months;
  • The purchaser invests at least $250,000 in the offering;
  • The purchaser has made representations regarding status as an accredited investor and that the $250,000 investment represents less than 25% of the purchaser’s net worth (by completing the questionnaire attached to the SIFMA memo); and
  • The firm is not aware of any facts that call the into question the status of the purchaser as an accredited investor.

One thing that Rule 506 has taught us is that SEC safe harbors tend to become minimum thresholds in practice; will the same thing happen with respect to this SIFMA guidance? Will law firms advise issuer clients that failing to follow one of the SEC safe harbors or the SIFMA guidance in a Rule 506(c) offering is simply too risky? Obviously, Rule 506(c) is still in its infancy and much remains to be seen regarding how it will be utilized by issuers and interpreted and enforced by the SEC, but the SIFMA memo is certainly an interesting step in fleshing out the meaning of the Rule.

 

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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