On July 3rd, the SEC issued guidance in the form of six new compliance and disclosure interpretations regarding accredited investor status. Two of the C&DIs relate to the calculation of income and assets for purposes of determining accredited investor status, and the remainder discuss verification methods under Rule 506(c). In general, the SEC continues to express a strict interpretation of its asset and income tests, as well as an unwillingness to expand safe harbors, but to instead force issuers to use their own judgment in applying the principles-based approach required by Rule 506(c).
The C&DIs can be found here.
General Guidance Related to Income and Net Worth Calculations
Income reported in Non-U.S. Dollars. Where annual income is not reported in U.S. dollars, the issuer may use the exchange rate in effect on the last day of the year for which income is being determined or the average exchange rate for that year. (C&DI 255.48)
Assets Held Jointly with Non-Spouse. Assets held jointly with a non-spouse may be included in the calculation for the net worth test to the extent of the investor’s percentage ownership of the assets. (C&DI 255.49)
Guidance Related to Accredited Investor Verification under Rule 506(c)
Rule 506(c), which permits general solicitation, requires a more stringent level of verification of an investor’s accredited investor status. The rule provides four non-exclusive safe harbor verification methods. The SEC issued guidance on two of the safe harbor verification methods and made it clear that the safe harbors are to be strictly interpreted.
Rule 506(c)(2)(ii)(A). This safe harbor provides that an issuer can verify status on the basis of income by reviewing any Internal Revenue Service form that reports the purchaser's income for the two most recent years and obtaining a written representation that the investor has a reasonable expectation of reaching the required income level necessary to qualify as an accredited investor for the current year.
- An issuer cannot rely on this safe harbor if an IRS form is not available for the most recently completed year. (C&DI 260.35)
- Comparable foreign tax forms for the required years do not satisfy the requirements of this safe harbor. (C&DI 260.36)
Rule 506(c)(2)(ii)(B). This safe harbor provides that an issuer can verify status on the basis of net worth by reviewing one or more specified types of documentation relating to assets and liabilities dated within the prior three months, and obtaining a written representation that all liabilities necessary to make a determination of net worth have been disclosed.
- An issuer cannot rely on this safe harbor if the documentation provided is more than three months old, even if it is the most recent information available. (C&DI 260.37)
- This safe harbor requires an issuer to review a consumer report from one of the "nationwide consumer reporting agencies" to determine the investor’s liabilities. A report from a foreign consumer reporting agency does not satisfy the safe harbor. (C&DI 260.38)
While the guidance makes clear that the safe harbors may not be read expansively, the guidance explicitly emphasizes that issuers, based on the type of documentation referenced in these C&DIs, could reasonably conclude that a purchaser is an accredited investor using a principles-based verification method.
For example, if an investor’s tax return is not yet available for the most recently completed year, although an issuer cannot rely on the safe harbor provided in Rule 506(c)(2)(ii)(A), “an issuer could reasonably conclude that a purchaser is an accredited investor” by reviewing the tax returns for the two years preceding the recently completed year, and obtaining a written representation from the purchaser (i) regarding the purchaser’s level of income for the recently completed year and that a tax return for the year is not available, and (ii) that the purchaser has a reasonable expectation of reaching the requisite income level for the current year.
Similarly, the SEC indicated that an issuer could reasonably conclude that an investor is an accredited investor by reviewing:
- comparable tax forms from a foreign jurisdiction that report income where the foreign jurisdiction imposes comparable penalties for falsely reported information;
- the most recently available tax assessment when determining whether the investor has the requisite net worth; or
- a consumer report from a non-U.S. consumer reporting agency that performs similar functions as a U.S. nationwide consumer reporting agency and taking any other steps necessary to determine the purchaser's liabilities (such as a written representation from the investor that all liabilities have been disclosed) in determining whether the investor has the requisite net worth.
Emphasizing again the issuer’s responsibility to carefully investigate accredited investor status, the SEC reminded issuers in each of these C&DIs that they must take additional steps to verify the investor’s status if any questions arise during their review of accredited investor status, and that “more diligence might be necessary” if a purchaser barely satisfies the income or asset test.