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How to Verify That Your Investor is Accredited

In the realm of private placements, discerning whether a potential investor is accredited is paramount.  Rule 506(c) demands issuers to take “reasonable steps” to confirm the accreditation of all investors during the securities sale. This entails requesting and scrutinizing evidence of an investor’s income or net worth.

Verification under Rule 506(c) can be achieved through either the principles-based approach or by adopting one of the specific verification methods outlined in Rule 506(c)(2)(ii). While issuers aren’t bound to use these methods, if they opt for them, they must adhere to the chosen method’s prerequisites, including the requirement that the provided documents are current. It’s imperative for issuers to maintain thorough records of their verification processes, regardless of the chosen method.

Principles-Based Verification: Under this approach, the determination of “reasonable steps to verify” is based on the unique characteristics of each investor and transaction, considering factors like the investor’s nature, claimed accredited status, available information about the investor, and the nature of the offering.

Specific Verification Methods for Natural Persons:

  1. Income-Based: This involves reviewing IRS forms reporting the investor’s income for the two most recent years and obtaining written confirmation that the investor expects to reach the income threshold for accredited status in the current year.
  2. Net Worth-Based: For an investor’s assets, issuers can review various documents like bank statements, brokerage statements, and tax assessments, dated within the past three months. Regarding liabilities, a report from a national consumer reporting agency is necessary, accompanied by written assurance that the investor has disclosed all relevant liabilities for the net worth assessment.
  3. Third-Party Confirmation: Issuers can obtain written confirmation from specific third parties (e.g., registered broker-dealers, licensed attorneys, or CPAs) stating that they’ve verified the investor’s accredited status within the past three months.

Additionally, there’s a safe harbor provision for individuals who were accredited investors in an issuer’s Rule 506(b) offering before the effective date of Rule 506(c).

Now, let’s turn our attention to the new CD&Is:

CD&I 260.35: This CD&I discusses the income-based verification method and highlights its unavailability during the early part of the year when the previous year’s tax returns have not yet been filed. In such cases, alternative verification methods must be employed.

CD&I 260.36: It addresses non-U.S. taxpayers who lack income tax returns, rendering the income-based verification method inapplicable. Alternative verification methods are necessitated.

CD&I 260.37: Focusing on the net worth-based verification method, this CD&I emphasizes that all documents related to an investor’s assets and liabilities must be dated within the past three months. Annual tax assessments, if outdated, are not acceptable.

CD&I 260.38: Regarding net worth-based verification, it clarifies that “nationwide consumer reporting agencies” must be U.S.-based.

CD&Is 255.48 and 255.49: These address the accredited status of an investor, discussing foreign income reporting and the inclusion of jointly owned assets in the net worth calculation.

Undoubtedly, these new CD&Is offer valuable guidance to issuers navigating Rule 506(c) offerings. However, it’s essential to note that the verification requirements are becoming more intricate. A comprehensive study of SEC guidance, the Rule itself, and accompanying releases is imperative before embarking on a Rule 506(c) offering.

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