SEC Staff Issues Guidance on Accredited Investor Tests and Verification of Accredited Investors for Rule 506(c) Offerings

by Goodwin
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The staff of the SEC’s Division of Corporation Finance added to its Compliance and Disclosure Interpretations posted on the SEC website new Questions 255.48-255.49 and 260.35-260.38 which address (1) elements of the accredited investor definition for natural persons in Rule 501 of Regulation D under the Securities Act of 1933 and (2) verification of accredited investor status for purposes of the Rule 506(c) private offering exemption under Regulation D (collectively, the “Guidance”).

Accredited Investor – Natural Persons

Income Not Reported in U.S. Dollars.  The Guidance states that an issuer determining whether a purchaser whose annual income is not reported in U.S. dollars meets the income test for qualifying as an accredited investor 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.

Assets Held Jointly with Non-Spouse.  The Guidance states 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 the purchaser’s percentage ownership of the account or property.

Verifying Accredited Investor Status

To rely on Rule 506(c), an issuer must take reasonable steps to verify the accredited investor status of purchasers in the offering, even if all purchasers are in fact accredited investors.  The SEC has described a principles-based approach to verification and provided factors for issuers to consider in making the necessary determinations.  Rule 506(c) also includes four non-exclusive safe harbor methods of verifying accredited investor status.  The Guidance describes situations where the strict terms of a safe harbor method have not been met and provides principle-based variations on the safe harbor methods for meeting Rule 506(c)’s verification requirement.  (See the June 23, 2013 Financial Services Alert for a more detailed discussion of Rule 506(c) offerings.)

IRS Forms Reporting Income.  The Guidance states that an issuer may not rely on the safe harbor verification method that involves reviewing any Internal Revenue Service form that reports the purchaser's income for the “two most recent years” if the form for the most recent year is not yet available, even though the forms for the prior two years are.  The Guidance provides, however, that an issuer may satisfy Rule 506(c)’s verification requirement under the principles-based method of verification by:

  • reviewing the IRS forms that report income for the two years preceding the recently completed year; and
  • 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. Tax Forms Reporting Income.  The Guidance states that an issuer may not rely on the safe harbor method that involves reviewing IRS forms that report the purchaser’s income for the two most recent years if the purchaser is not a U.S. taxpayer and therefore cannot provide an Internal Revenue Service form that reports income, even the non-U.S. purchaser can provide comparable tax forms from a foreign jurisdiction.  The Guidance provides, however, that an issuer may satisfy Rule 506(c)’s verification requirement under the principles-based method of verification by reviewing filed tax forms from a non-U.S. jurisdiction that report income if that jurisdiction imposes penalties for falsely reported information that are comparable to those that apply to false reporting on IRS forms.

Tax Assessments.  The Guidance notes that because tax assessments are often prepared annually it may not always be possible for an issuer to use them to rely on the safe harbor method that involves reviewing documentation of the purchaser's assets and liabilities dated within the prior three months.  The Guidance provides, however, that an issuer may satisfy Rule 506(c)’s verification requirement under the principles-based method of verification if it uses the most recently available tax assessment when determining whether the purchaser has the requisite net worth. The Guidance notes that, 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.

Report from a Non-U.S. Consumer Reporting Agency.  The Guidance states that if, in order to determine the purchaser's liabilities, an issuer reviews a consumer report from a non-U.S. consumer reporting agency that performs functions similar to those of a U.S. nationwide consumer reporting agency, the issuer has not met the requirement for the safe harbor in Rule 506(c)(2)(ii)(B) that it review a consumer report from one of the “nationwide consumer reporting agencies” to make that determination.  The Guidance provides, however, that an issuer may satisfy Rule 506(c)’s verification requirement under the principles-based method of verification by reviewing a consumer report from such a non-U.S. consumer reporting agency 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).

Reason to Question the Information Reviewed.  In addressing each of the foregoing situations, the Guidance notes that if, after undertaking the principles-based inquiry described for that situation, the issuer has reason to question the conclusion that inquiry is designed to support, e.g., because the information reviewed appears unreliable, then the issuer must undertake additional measures to establish that it has taken reasonable steps to verify the purchaser’s accredited investor status.  The Guidance provides an example of how such a question might arise in the situation where the issuer undertakes the principle-based review of IRS forms described above to determine the purchaser’s income.  The Guidance observes that “if, based on that review, the purchaser's income for the most recently completed year barely exceeded the threshold required, the review described in the Guidance might not constitute sufficient verification and more diligence might be necessary.”

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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