SIFMA Guidance on Rule 506c Verification
In July 2013, the SEC amended Rule 506 of Regulation D under the Securities Act of 1933 to permit the use of general solicitation in securities offerings conducted under new paragraph (c) of Rule 506, provided that all purchasers in the offering are “accredited investors” and the issuer takes “reasonable steps” to verify such status. This “reasonable verification” requirement applies only to Rule 506(c) offerings, is separate from the requirement that sales be limited to accredited investors and must be satisfied even if all purchasers happen to be accredited investors. These amendments took effect on September 23, 2013.
The SEC set forth a list of four non-exclusive safe harbor methods by which the “reasonable verification” requirement for a Rule 506(c) offering is deemed to be satisfied with respect to purchasers who are natural persons. Two of these safe harbor methods, however, require purchasers to provide personal financial information about their annual income or the amount of their assets and liabilities; and as the SEC has recognized, individuals have “privacy concerns about the disclosure of personal financial information.” Another safe harbor method permits an issuer to rely on the written confirmation of accredited investor status issued by a registered broker-dealer or investment adviser, licensed attorney or certified public accountant, but these third parties have to take reasonable steps to verify the purchaser’s accredited investor status before providing their written confirmation.
SIFMA has issued this Memorandum to provide guidance to registered broker-dealers and investment advisers on some verification methods they could use to comply with the requirements of the safe harbor method designated for them with respect to purchasers who are natural persons as well as on some verification methods they could use to determine whether certain legal entities qualify as accredited investors. This guidance may also be useful to issuers and other market participants. These methods are not intended to be exclusive and are only examples of the types of methods that we believe can constitute reasonable steps to verify in light of the facts and circumstances outlined here. This Memorandum does not constitute legal advice by SIFMA to our members or to anyone else.
1 See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-9415 (July 10, 2013) [78 FR 44771] (“Rule 506(c) Release”).
2 Rule 506(c) Release at 44779.
3 The fourth safe harbor relates to natural persons who invested in an issuer’s Rule 506(b) offering as accredited investors prior to the effective date of Rule 506(c) and is not discussed here.
Rule 506 of Regulation D sets forth the conditions under which issuers can offer and sell securities to “accredited investors” in offerings exempt from the registration requirements of Section 5 of the Securities Act. Under Rule 501(a) of Regulation D:
A natural person can qualify as an “accredited investor” if:
- he or she had more than $200,000 of annual income in each of the two most recent years (or more than $300,000 with spouse) with a reasonable expectation of reaching the same income level in the current year (the “annual income test”); or
- he or she has an individual net worth (or joint net worth with spouse) in excess of $1 million, not including the person’s primary residence (the “net worth test”).4
A legal entity can qualify as an “accredited investor” on the basis of either:
- its status alone (e.g., a registered broker-dealer, bank or insurance company); or
- both its status and its assets (e.g., a corporation, partnership, 501(c)(3) organization or employee benefit plan, each with assets in excess of $5 million).
In adopting Rule 506(c), the SEC determined not to require the use of any specific method to verify a purchaser’s accredited investor status in Rule 506(c) offerings because, in its view, a required verification method could be overly burdensome in some cases and in other cases “impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor, as well as the potentially wide range of verification issues that may arise….”5 Instead, the SEC provided issuers and market participants with the flexibility to adopt different approaches to verification by requiring only that the steps taken be “reasonable.” This is an objective determination, based on the facts and circumstances of the purchaser and the transaction.