Under Rule 506(c), companies can now engage in a general solicitation in conducting private placements but if they do so, they must verify that each purchaser is accredited.  The SEC has provided some safe harbors for verification and will also allow “principles based verification” if the verification is adequate.  On July 3, 2014, the SEC issued Compliance and Disclosure Interpretations, some of which deal with the issue of how to determine accredited investor status under Rule 506(c).  The questions dealing with this issue and the Staff’s interpretation follow:

  • In determining whether an investor is accredited when his annual income is not reported in US dollars, the issuer should use the exchange rate on the last day of the prior year or the average exchange rate for the prior year.  (Question 255.48)
  • Assets in an account or property held jointly with a person who is not the prospective purchaser’s spouse may be included in the calculation of net worth but only to the extent of the investor’s percentage ownership in the account or property. (Question 255.49)
  • Rule 506(c)(2)(ii)(A) provides a non-exclusive safe harbor to verify that a purchaser is an accredited investor by reviewing any IRS form that reports the prospective purchaser’s income for the two most recent years.  (These forms could include a Form W-2, Form 1099, Schedule K-1 or Form 1040.)  The CD&I provides that the safe harbor is not available if, because of the fact that a return for the most recent year is not available, the issuer relies on the two prior years.  However, the SEC states that the principles based verification method may be satisfied if the issuer relies on the two prior years that are available and also obtains written representations from the prospective purchaser that (i) an IRS form that reports his income for the recently completed year is not available; (ii) specify the amount of income he received for the most recently completed year; and (iii) he has a reasonable expectation of reaching the requisite income level in the current year.  The SEC cautions that if the issuer has reasonable grounds to question the information provided (such as if the prospective investor barely meets the income requirements), the issuer would need to take additional steps to verify accredited investor status.  (Question 260.35)
  • The safe harbor granted for issuers relying on US tax returns is not available to an issuer relying on foreign tax returns of a prospective purchaser who does not file US returns.  However, the principles based verification method may be satisfied if the issuer relies on foreign tax returns of a foreign jurisdiction that imposes penalties for falsely reporting information similar to those imposed by the IRS.  However, if after reviewing these forms, the issuer has reason to believe that the investor may not be accredited, the issuer must engage in additional due diligence.  (Question 260.36)
  • Rule 506(c)(2)(ii)(B) grants a safe harbor if the issuer reviews certain documents evidencing an accredited investor’s net worth as long as the documents are not more than three months old.  In the CD&I, the SEC states that this safe harbor is not available for verification of net worth based on tax assessments that are more than three months old.  Nevertheless, the principles based verification method may be satisfied if the issuer uses the most recent tax assessment.  If the issuer has reason to question whether the assessment reasonably reflects the value of the purchaser’s assets, it must take additional measures to verify that the prospective purchaser is accredited.  (Question 260.37)
  • The safe harbor provided by Rule 501(c)(2)(ii)(B) requires an issuer to review a consumer report from a national consumer reporting agency.  The CD&I provides that this safe harbor is not met by reliance on a report from a foreign consumer reporting agency.  However, an issuer could reasonably conclude that a purchaser is accredited under the principles-based verification method if it relies on a foreign report and takes other steps necessary to determine the purchaser’s liabilities such as a written representation from the purchaser that all liabilities have been disclosed.  (Question 260.38)