One of the shortcomings of the 506(b) exemption is that a sponsor is not permitted to utilize general solicitation to advertise the offering. A sponsor may only offer the securities to a person with whom he or she already has a relationship. However, general solicitation is permitted under the provisions of Rule 506(c). The catch is that only accredited investors can invest in 506(c) offerings. The sponsor of these offerings must take reasonable steps to verify the accredited investor status of each investor. The SEC has provided certain so-called “safe harbors” to help sponsors with accredited investor verification.
Below is a review of three methods to determine individual accredited investor status:
Third Party Verification
Through this method, an investor is verified as an accredited investor through a third party. According to the SEC, registered broker-dealers, SEC-registered investment advisers, licensed attorneys, or certified public accountants are authorized to provide third party certification. One of these professionals can write and sign a letter that consists of safe harbor evidence of the investor’s accredited status.
The sponsor may also utilize a third-party accredited investor company to perform verification. This type of company can provide a dated letter or certificate for a particular fee. This option enables the investor to obtain a verification letter without needing to contact one of his or her financial professionals. The time, risk, and burden are placed into the hands of the third-party providing the service. This is a viable option when the investor wants to keep his or her participation in the private placement offering private. This is also easy for the sponsor, since it allows the sponsor to simply accept the letter as evidence of the investor’s verification status and be in compliance with the law.
Note that while Third Party Verification is considered a safe harbor by the SEC, the investor must still meet the definition of an accredited investor; this means they still need to qualify based on their income or net worth, but can use this method if they wish to avoid disclosing personal financial information.
Income Test
With the income test, the investor must provide documented evidence of his or her income to the sponsor for verification. The investor’s income must exceed $200,000 USD (or $300,000 USD jointly with their spouse) in both of the two previous calendar years, and represent that they have a reasonable expectation of earning the same or greater level of income in the current year. The investor may show pay stubs, W-2s, or 1099s as part of the required documentation.
Net Worth Test
With the net worth test, the individual must demonstrate a net worth greater than $1 million (with or without a spouse), minus the value of his or her primary residence. However, if the home is underwater or mortgage debt has accumulated in the previous 60 days, these facts would be countedwork against the investor and reduce his or her net worth.
The investor needs to provide the following as part of the accredited investor Net Worth verification process:
- Credit report from a credit reporting company that shows liabilities if it is available, and
- Documentary evidence (i.e. brokerage statements, bank statements, loan statements, third-party appraisals or BPOs, other relevant documents) for calculating net worth, and
- A statement specifying that the investor does not have undisclosed liabilities
If you are interested in utilizing a third-party verification service to make the process of accredited investor verification much easier, contact an experienced investor verification company today to get started.
