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Blog

The Importance of “Reasonable Steps” Verification

Mihir Gandhi

Do you need to verify yourself as an accredited investor, or are you looking to validate a purchaser before selling private securities? The "reasonable steps" outlined by the United States Securities and Exchange Commission guide and instruct issuers on how they should verify prospective purchasers. Only accredited investors are permitted to engage in private offerings through general solicitation. For this reason, it's important that businesses and small startups make it a point to adhere to the provisions of the Securities Act and JOBS Act by first validating investors' statuses.

JOBS Act & Rule 506

Since September of 2013, small startups and businesses have had the freedom to engage in general solicitation while still conducting private offerings. However, to accommodate the new provisions outlined in Title II of the JOBS Act, the SEC made some additions to Rule 506 of Regulation D. Rule 506(c) was implemented to aid purchasers and issuers in the process of securities sales and purchases. To use Rule 506(c), issuers need to acquire proof of an investor's alleged accredited status – the use of self-certification through signed statements is not sufficient. Reasonable steps verification helps protect sellers and purchasers, and ensures that private offerings are SEC-compliant.

Why Accreditation is Crucial  

The definition of an investor who's accredited by SEC standards is given under Rule 501 of Regulation D. Accreditation can be achieved by individuals or entities who meet certain income and asset requirements. Self-surveys and self-validations are longer sufficient methods of proving an investor holds an accredited status. Therefore, whether you're a purchaser or issuer, it's necessary to request verification services for yourself or for a potential investor before proceeding with a transaction involving private securities. Not obtaining verification before conducting private offerings can lead to having to return money to investors and/or a temporary ban from certain types of fundraising.

SEC’s Validation Guidelines

In light of general solicitation becoming available to startups, the SEC released a set of guidelines issuers can follow to verify an investor before selling private securities. The actions outlined in these guidelines are not mandatory, but are considered acceptable forms of accreditation validation. For example, if an investor is willing to provide personal financial information, you can verify their income and net worth by reviewing W-2s, bank statements, appraisal reports, etc. Third-party reviewers are a great way to verify, but it’s important to note that the SEC only allows third party reviewers that one has a reasonable basis to rely upon.  For the gold standard, make sure your third-party reviewer utilizes licensed attorneys to perform the verification reviews.