Issuers of securities are required to take reasonable steps to verify investors as accredited for transactions operating under Rule 506(c) which involve general solicitation. Rule 506(c) permits general solicitation and advertising with the sale, offer, and issuance of common stocks, convertible notes, and preferred stock without the requirement to register those shares with the Securities and Exchange Commission (SEC). However, only if the sales are conducted with accredited investors, and reasonable steps verification are performed by the issuer to verify the purchasers are accredited investors.
What are Reasonable Steps?
The reasonable steps taken must provide the issuer with a reasonable belief that all the investors participated are accredited. There are various factors that determine what reasonable steps are necessary for an issuer to take. These include:
- The type and quantity of information the issuer possesses about the purchaser
- The type of accredited investor and the nature of the purchaser
- Characteristics of the offering, including how the issuer solicited the purchaser
Safe Harbor for Reasonable Steps Verification
The SEC issued a nonexclusive safe harbor in its adoption of Rule 506(c) which helps issuers determine if they are complying with the reasonable steps required for individual investors.
Generally speaking, there exist three common ways to operate within a safe harbor to Rule 506(c). The following generally explain the safe harbor requirements:
- For an accredited investor status based on income, the issuer needs to review IRS forms (certain exemptions apply for foreign investors) that verify the investor’s income for the previous two years and obtain written verification that the investor reasonably expects to acquire the same income level or greater within the current year.
- For an accredited investor status based on net worth, the issuer must evaluate certain documents that show the investor’s assets and liabilities using evidence no older than 90 days. This must include a consumer report regarding liabilities. The issuer must also receive a written representation from the investor that the investor has revealed all liabilities required to adequately determine the net worth of the investor.
- Regardless of whether the status of the accredited investor is based on net worth or income, the issuer may receive a written confirmation from a CPA, licensed attorney, or other specifically listed individuals in the rule that the individual has conducted reasonable steps verification of the investor’s accredited investor status using evidence no older 90 days and has determined that the investor is an accredited investor.
Even though the safe harbors mentioned above are non-exclusive and not required, the majority of issuers working with individual purchasers are inclined to place themselves within the safe harbors by any means necessary to avoid becoming the object of disapproval by the SEC regarding a failure to conduct reasonable steps verification.
