By Kaiser Wahab
With the creation of new Rule 506(c) under the JOBS Act, private placement issuers are now authorized to leverage general solicitation, provided they verify that each purchaser in the offering is an accredited investor. In theory, this is a very powerful concept, however there is still some confusion as to how that verification standard works and what it actually has to look for. Fortunately, the SEC has set out guidance for verification procedures, including the “principles based verification” allowance if verification is adequate. The SEC, on July 3, 2014, issued its “Compliance and Disclosure Interpretations” (“CD&Is”), a portion of which address the issue of how to determine accredited investor status under Rule 506(c). Below is a summary of those CD&Is as they pertain to Accredited Investor verification:
- Joint Investor Property with Non-Spouse: It is now permissible to factor in the assets residing in an account or property that is held jointly with an individual who is not the prospective purchaser’s spouse, to determine the net worth of the prospective investor (but only to the extent of the investor’s actual percentage ownership in any such account or property).
- Foreign Currency Measured Income: When verifying the accredited status of investors whose income is not measured nor reported in US dollars, the issuer should employ the applicable exchange rate as of the last day of the preceding year, or in the alternative, the average exchange rate for the preceding year.
- IRS Forms Verifying Investor Income for the past Two Years: A nonexclusive safe harbor, whereby the issuer may verify the accredited status of an investor by reviewing any IRS form (e.g., any of a Form W-2, Form 1099, Form 1040, or Schedule K-1) that reports such investor’s income for the two most recent years is set forth under Rule 506(c)(2)(ii)(A). However, the CD&Is make clear that where a tax return for the most recent tax year is unavailable, the safe harbor will not be viable for an issuer relying on the two prior years’ returns. However, the SEC has indicated in situations where the issuer relies on the two available prior years in addition to acquiring from the investor written representations as follows: (i) there is no IRS form that reports such investor’s income for the recently completed year; (ii) the amount of income such investor earned for the most recent year; and (iii) the fact the investor has a reasonable expectation of achieving the necessary income level in the current year of the principles based verification inquiry. The SEC further clarified that if the issuer has cause to call into suspect the information provided on such forms, the issuer will be required to take additional steps to verify accredited investor status.
- Foreign Tax Returns: Issuers relying on the safe harbor based on US tax returns cannot leverage such safe harbor when relying on foreign tax returns of prospective investors lacking US returns. However, an issuer relying on foreign tax returns of a nation that penalizes false information in a manner similar to the IRS, principles based verification may be satisfied. In any event, if after reviewing such foreign tax forms, the issuer still has cause to believe the subject investor may not be accredited, additional due diligence is likely required.
- Investor Financial Docs Less than 90 Days Old: If the issuer reviews documents that purport to demonstrate an accredited investor’s net worth that are less than 90 days old, that issuer may be able to rely on the Rule 506(c)(2)(ii)(B) safe harbor. The CD&Is make clear this safe harbor does not apply to net worth verification based on tax assessments more than 90 days old. However, the principles based verification approach may be satisfied if the issuer is relying upon the most recent tax assessment. If the issuer has cause to suspect whether the assessment reasonably reflects the value of the investor’s assets, the issuer will have to take additional steps to verify that the investor is accredited.
- National Consumer Reporting Agency: Rule 501(c)(2)(ii)(B)’s safe harbor mandates that an issuer must review a national consumer reporting agency’s consumer report. Relying on a foreign consumer reporting report will not satisfy the safe harbor. Issuers using the principles-based verification method may still come to the reasonable conclusion that an investor is accredited, provided reliance on a foreign report is supplemented with other steps to determine the investor’s liabilities (e.g., securing written verification and representation from the investor that all liabilities have been disclosed).