On July 3, 2014, the staff of the SEC’s Division of Corporation Finance issued guidance on reasonable steps to verify the accredited investor status of purchasers for purposes of the Rule 506(c) exemption that permits general solicitation. The guidance, which is in the form of several Compliance and Disclosure Interpretations (CDIs) described below, indicates that the requirements of the rule’s income and net worth safe harbors for natural persons will be strictly applied. However, the guidance underscores that the rule is principles based and the failure to comply with a safe harbor does not mean that the issuer has not taken “reasonable steps to verify” an investor’s accredited status. Indeed, the guidance shows how the factors underlying the safe harbors can support a determination that reasonable verification steps have been taken under a principles-based analysis. The guidance includes, however, a cautionary reminder that, unlike the safe harbors, reliance on a principles-based analysis requires consideration of all the relevant facts and circumstances and may require additional verification steps depending on the circumstances.
The CDIs provide the following specific guidance:
- Income in foreign currencies can be converted to U.S. dollars using either the exchange rate in effect on the last day of the applicable year or the average rate for that year. (CDI 255.48)
- Property held jointly or in a joint account with a non-spouse can be counted for the net worth test, but only to the extent of the purchaser’s percentage ownership of the joint property or account. (CDI 255.49)
- If the IRS form reporting income for the most recently completed year is unavailable, the income safe harbor would not be available, but an issuer could satisfy the reasonable verification requirement under the principles-based method by reviewing IRS forms for the two prior years and by obtaining a written representation from the purchaser of his or her income for the recently completed year, as well as of his or her reasonable expectation of reaching the required income level for the current year. However, because the principles-based method is being used, if there is doubt about the ability to rely on the self-certification, the issuer may have to do more. For example, an income level that barely meets the required income level might, depending on the circumstances, require additional verification steps. (CDI 260.35) Although the guidance adds an extra year to the look back period for meeting the required income level to qualify as an accredited investor based upon reliance on IRS forms and self-certification, an issuer may be able, depending on the circumstances, to reasonably verify in other ways under the principles-based method that a purchaser has met the required income level for the most recently completed year and the prior year.
- Although foreign tax forms reporting income cannot be used to satisfy the income safe harbor, they could be used under the principles-based verification method so long as they are reliable. The guidance notes that the Commission considered that there are penalties for falsely reporting income on IRS forms. Comparable penalties in a foreign jurisdiction would support the reliability of foreign tax forms. However, if the issuer has reason to question the information’s reliability, it would have to take additional verification steps. (CDI 260.36)
- Tax assessments that are more than three months old, for example because they are only prepared annually, cannot be used for the net worth safe harbor. However, use of the most recent tax assessments, even though more than three months old, could be used under the principles-based method if justified by the circumstances. For example, if there is a sufficient cushion in net worth based on the tax assessment to eliminate concern over diminution in value, the reasonableness of the reliance would be enhanced. On the other hand, if the issuer has reason to question whether the assessment reflects the value of the asset, it may have to take additional verification steps. (CDI 260.37)
- A consumer report from a foreign consumer reporting agency would not satisfy the safe harbor requirement for determining net worth because that safe harbor requires a report from one of the U.S. national consumer reporting agencies. However, such a report could be used under the principles-based method, along with other steps to determine the purchaser’s liabilities, such as a written certification from the purchaser, so long as the issuer has no reason to believe that the report and certification do not reliably represent the purchaser’s liabilities. (CDI 260.38)
Although the staff has not added flexibility to the safe harbors, it has provided useful guidance by recognizing that steps analogous to those under the safe harbors can be used under a principles-based approach to verification if it is reasonable to do so under the circumstances, which includes the issuer not having reason to question the reliability of the information being relied upon.
For any questions regarding this alert, please contact one of the authors listed above.