Category: Investor Verification

SEC Relaxes Accredited Investor Verification Rule For Wealthy People

SEC Relaxes Accredited Investor Verification Rule For Wealthy People

On By crowdfundattnyIn Investor, Investor Verification, Rule 506(c), SEC2 Comments

An issuer raising capital using Rule 506(c) must take “reasonable steps” to verify that all the investors are accredited. Until now, that has normally meant using a third party like VerifyInvestor, which in turn gets a letter from the investor’s accountant. Now it’s going to be a little easier, at least for investors writing big checks.

In a private no-action letter, the SEC allowed the issuer to verify investors without looking at the investor’s tax returns, seeing a letter from the investor’s accountant, or using any of the other methods described in the regulations under Rule 506(c) if:

  • The investor is writing a big enough check — $200,000 for an individual and $1 million for an entity; and
  • The investor promises that he, she, or it is accredited and has not financed the investment through a third party; and
  • The issuer does not have actual knowledge of any facts indicating that the investor is not accredited or has financed the investment.

Technically, the no-action letter doesn’t have the same force as a statute or a regulation. It does, however, reflect the view of the staff of the SEC. Issuers and their lawyers generally can rely on no-action letters, with the understanding that the staff could decide to withdraw or modify its position at any time.

Verifying that an investor is accredited was already so easy, the question is why anyone bothered to ask for this no-action letter. I’m afraid the answer is that growing income and wealth disparities in this country. In some socio-economic circles and for some funds, everyone writes big checks, just as everyone is a “qualified purchaser” for purposes of section 3(c)(7) of the Investment Company Act. The result of the no-action letter is that for that segment of American society, the verification rules no longer exist. 

Two sets of rules, one for the wealthy, another for everyone else. I certainly understand the logic of the no-action letter, but I’m not sure it’s healthy in a macro sense. 

Questions? Let me know.

Investor Verification: Questions & Answers from The SEC

On By crowdfundattnyIn Investor, Investor Verification, Rule 501(a)(5), SEC, Securities Exchange CommissionLeave a comment

The SEC recently issued four questions and answers dealing with investor verification.

Question #1

If a purchaser’s annual income is not reported in U.S. dollars, what exchange rate should an issuer use to determine whether the purchaser’s income meets the income test for qualifying as an accredited investor?

Answer: The issuer may use either the exchange rate that is in effect on the last day of the year for which income is being determined or the average exchange rate for that year.

Question #2

Can assets in an account or property held jointly with another person who is not the purchaser’s spouse be included in determining whether the purchaser satisfies the net worth test in Rule 501(a)(5)?

Answer: Yes, assets in an account or property held jointly with a person who is not the purchaser’s spouse may be included in the calculation for the net worth test, but only to the extent of his or her percentage ownership of the account or property. [July 3, 2014]

Question #3

Rule 506(c)(2)(ii)(A) sets forth a non-exclusive method of verifying that a purchaser is an accredited investor by, among other things, reviewing any Internal Revenue Service form that reports the purchaser’s income for the “two most recent years.” If such an Internal Revenue Service form is not yet available for the recently completed year (e.g., 2013), can the issuer still rely on this verification method by reviewing the Internal Revenue Service forms for the two prior years that are available (e.g., 2012 and 2011)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. We believe, however, that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by:

  • Reviewing the Internal Revenue Service forms that report income for the two years preceding the recently completed year; and
  • Obtaining written representations from the purchaser that (i) an Internal Revenue Service form that reports the purchaser’s income for the recently completed year is not available, (ii) specify the amount of income the purchaser received for the recently completed year and that such amount reached the level needed to qualify as an accredited investor, and (iii) the purchaser has a reasonable expectation of reaching the requisite income level for the current year.

Where the issuer has reason to question the purchaser’s claim to be an accredited investor after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor. For example, if, based on this review, the purchaser’s income for the most recently completed year barely exceeded the threshold required, the foregoing procedures might not constitute sufficient verification and more diligence might be necessary.

Question #4

A purchaser is not a U.S. taxpayer and therefore cannot provide an Internal Revenue Service form that reports income. Can an issuer review comparable tax forms from a foreign jurisdiction in order to rely on the verification method provided in Rule 506(c)(2)(ii)(A)?

Answer: No, the verification safe harbor provided in Rule 506(c)(2)(ii)(A) would not be available under these circumstances. In adopting this safe harbor, the Commission noted that there are “numerous penalties for falsely reporting information” in Internal Revenue Service forms. See Securities Act Release No. 33-9415 (July 10, 2013). Although the safe harbor is not available for tax forms from foreign jurisdictions, we believe that an issuer could reasonably conclude that a purchaser is an accredited investor and satisfy the verification requirement of Rule 506(c) under the principles-based verification method by reviewing filed tax forms that report income where the foreign jurisdiction imposes comparable penalties for falsely reported information.

Where the issuer has reason to question the reliability of the information about the purchaser’s income after reviewing these documents, it must take additional verification measures in order to establish that it has taken reasonable steps to verify that the purchaser is an accredited investor.

The Takeaway

The lesson is that issuers and portals should not try to verify investors on their own. Leave that to a third party service like Crowdentials or VerifyInvestor – they keep track of these rules so you won’t have to.

Questions? Let me know.