Accredited Investor Status Under Rule 506(c) l Securities Lawyer 101

Rule 506 is the most commonly used exemption of the Regulation D of the Securities Act of 1933, as amended (the “Securities Act”).   Issuers conducting Rule 506 Offerings, issuers may use general solicitation and advertising in their securities offerings so long as certain requirements are met including that the issuer take reasonable steps to confirm that each investor is an accredited investor as defined by Rule 506 of Regulation D.  Rule 506(c) includes “disqualifying events” for “covered persons” which prevent the issuer from relying on the Rule 506 exemption. This post summarizes how issuers can determine accredited investor status in Rule 506(c) offerings.

Overview of Rule 506(c)

Rule 506(c) allows an issuer to use general solicitation and advertising to sell its securities if the issuer must take reasonable steps to verify that investors are accredited investors. 

Under Rule 501 of Regulation D, an accredited investor is  any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

• Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
• Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
• Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
• Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
• Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000. For purposes of calculating net worth the following shall  not be included, (i) The person’s primary residence, (ii) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and (iii) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability.

• Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
• Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in §230.506(b)(2)(ii); and
• Any entity in which all of the equity owners are accredited investors.

Laundry List of Methods to Determine Accredited Investor Status

The final rule adopting Rule 506(c) set out a non-exclusive laundry list of ways that issuers may satisfy Rule 506′s accredited investor verification requirement. These include a review of:

• IRS forms such as tax returns for the two most recent years and written representations regarding the investor’s expected income level for the current year;
• Bank statements, brokerage statements and/or tax assessments, to determine assets, and a consumer report or credit report from at least one consumer reporting agency to assess liabilities;
• Written confirmation from a registered broker-dealer, registered investment advisor or CPA; and
• A certification for investors prior to adoption of Rule 506(c).

Risks of General Solicitation and Advertising in Rule 506 Offerings

If an investor provides false information to an issuer claiming status as an accredited investor, the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption if the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.  That is, however, a situation best avoided by companies engaged in Rule 506 placements.  It’s best for them to design a protocol that will enable them to identify genuine accredited investors with accuracy.  Inattention to detail could put the offering at risk and expose the issuer to Section 5 liability under the Securities Act. Additionally, the issuer could be forced to offer rescission to investors int he Rule 506 offering.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com.   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855
www.SecuritiesLawyer101.com