Harmony in music is when two or more pitches are played together. Singers generally can sing only one pitch at a time. And most instruments usually can play only a single pitch. On the other hand, keyboard instruments, such as the piano or harpsichord, can play numerous notes simultaneously.

Playing two notes at once (double stops) is an intermediate string instrument technique. More advanced string players can play three notes simultaneously in a triple stop. Triple stops require significant pressure on the strings to engage three strings at once, and it is challenging to play all three notes without sounding scratchy.

The curvature of the bridge prevents string players from playing four notes at once. However, violinists and violists can play four pitches (quadruple stops) so quickly that they sound like they are being played simultaneously.

Most people don’t know that advanced wind instrument players can create a multiphonic, which sounds two notes simultaneously. When I played the clarinet, sometimes, I could adjust my embouchure (mouth position) or fingerings to create a multiphonic. But there are limits on which multiphonics a clarinet can produce.

No matter what the instrument, harmonization adds complexity because it is more challenging to play than a single note melody. In contrast, harmonization of laws involves creating uniform standards or laws. For laws, harmonization can be a synonym for simplification.

On November 2, 2020, the Securities and Exchange Commission (SEC) amended several rules to harmonize requirements for exempt offerings, which will be effective in 2021 (60 days after publication in the Federal Register). The revised rules were designed to help small issuers raise money in private markets. These changes also will help real estate sponsors raise money through the private placements they commonly use.

This article is the first in a series discussing changes in the new SEC rules. This article focuses on changes to the investor verification process in Rule 506(c) offerings.

History of Rule 506(c)

The Jumpstart Our Business Startups Act of 2012 directed the SEC to create an exemption that permitted general advertising and general solicitation. In response, the SEC added Rule 506(c) to Regulation D, which created an exemption for publicly advertised securities offerings.

Rule 506(c) limits sales to accredited investors who meet net worth, asset, or income requirements. Plus, although investors may self-certify their accredited status for a Rule 506(b) offering, they cannot do so under Rule 506(c). Rule 506(c) requires more intense scrutiny into investors’ financial situations than Rule 506(b) since the issuers must take reasonable steps to verify that the investors are accredited.

In the adopting release for Rule 506(c), the SEC took a “principles-based approach,” which allowed issuers to consider several factors when determining whether the verification methodology was reasonable. Some of the interconnected, non-exclusive factors the issuer might consider include:

• “The nature of the purchase and the type of accredited investor that the purchaser claims to be;

• The amount and type of information that the issuer has about the purchaser; and

• The nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.”

Also, issuers can continue to rely upon self-certification for investors who invested in one of the issuer’s Rule 506(b) offerings before Rule 506(c) was adopted can continue.

Rule 506(c) also includes safe harbors for issuers verifying accredited investor status by one of these methods:

• Reviewing the investor’s prior two years’ income tax returns and obtaining written investor certification that the investor reasonably expects to reach the required income level ($200,000 for an individual and $300,000 for a married couple) in the current year;

• Reviewing recent (within the last three months) verification of the investor’s assets via bank or brokerage statements, appraisal reports, or similar documents and verify liabilities via a credit report;

• Obtaining written confirmation from the investor’s broker-dealer, investment advisor, attorney, or certified public accountant that the investor is accredited based upon information verified within the last three months.

The safe harbors are not mandatory. Yet, concerns of issuer liability for erroneous conclusions have prompted the creation of investor verification services. For a fee, these services will review investor documentation and verify that the investor is accredited. However, this verification is costly and time-consuming.

Because of Rule 506(c)’s shortcomings, it remains eclipsed by Rule 506(b) for raising funds in small business and real estate equity offerings. One challenge in Rule 506(c) offerings has been verification of accredited investor status.

Under Rule 506(b), highly accredited investors may disclose only the information necessary to demonstrate they meet the income or net worth requirements. The additional scrutiny into prospective investors’ finances required to invest in Rule 506(c) offering can be a deterrent for investment by high net worth individuals who desire to maintain financial privacy. Because the safe harbors require current documents, investors may find themselves repeatedly certifying their accredited status.

Simplified Income Verification for Rule 506(c) Investors

The SEC’s new rule adds the following language at the end of Rule 506(c):

In regard to any person that the issuer previously took reasonable steps to verify as an accredited investor [in accordance with Rule 506(c)], so long as the issuer is not aware of information to the contrary, obtaining a written representation from such person at the time of sale that he or she qualifies as an accredited investor. A written representation under this method of verification will satisfy the issuer’s obligation to verify the person’s accredited investor status for a period of five years from the date the person was previously verified as an accredited investor.

An issuer now has to verify an investor’s accredited status only once every five years as long as the investor certifies that they remain accredited. The hope is that by reducing the burden of investor verification, more issuers will use Rule 506(c).

The Future of Investor Verification Under Rule 506(c)

Although the changes may help issuers who plan serial Rule 506(c) offerings, they don’t relieve the burden for issuers moving into the Rule 506(c) market. Several commentators asked for clarification or expansion of the current principles-based verification method, which might have helped new Rule 506(c) issuers navigate the transition from Rule 506(b) to Rule 506(c).

Unfortunately, it doesn’t look like additional changes will be coming soon. Although the SEC acknowledged that further clarification might be welcome, he SEC not only didn’t make the suggested changes, but it reaffirmed the current method, stating

We continue to believe that requiring issuers to consider their particular facts and circumstances in establishing a reasonable basis for their determination of accredited investor status for Section 12(g) purposes provides issuers with appropriate flexibility for making the determination.

Given the limitations of the safe harbors and facts and circumstances nature of the evaluation outside of the safe harbor, issuers should consult with an experienced securities attorney before pursuing an offering under Rule 506(c).

This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.