The Impact of New Rule 506(c): Proposed Changes Would Simplify Accredited Investor Verification, Save Time and Money

Because broad solicitation and advertising are very important to many issuers of private placement offerings, Rule 506(c) of Regulation D of the Securities Act is a popular exemption from SEC registration requirements. Now, a newly proposed addition to the list of Rule 506(c) investor verification methods is expected to ease the process. Additionally, we’ll cover other situations when the rule requires fewer verification steps than usual.

Rule 506(c) of Regulation D allows general advertising and solicitation if issuers sell only to “natural persons” or entities meeting certain accredited investor criteria. Specifically, to become an accredited investor, an individual must have a net worth equal to or greater than $1 million USD, or their income must be over $200,000 USD per year for two consecutive years (or $300,000 USD jointly with a spouse). Although the net worth calculation excludes the value of their primary residence, it discounts all other liabilities, such as those greater than the value of the primary residence, as well as liabilities incurred on their primary residence in the past 60 days. The income test requires an individual to exceed the appropriate income threshold for two previous years, and they must expect to exceed it in the current year. Notably, it is the legal responsibility of an issuer to take “reasonable steps” to verify its accredited investors. This generally involves obtaining financially sensitive documentation from the issuer or entrusting a reliable third-party verification service, such as VerifyInvestor.com, to conduct the verification.

Proposed new rules released in March would lessen the required “reasonable steps” that Rule 506(c) issuers must take to verify accredited investors with whom they already have a relationship. Here’s how it works: if the issuer took “reasonable steps” to verify an accredited investor previously, then they would generally not need to re-verify the investor in a later sale. Instead, the issuer would simply need to write that the investor still remains accredited, as long as the issuer has no knowledge to the contrary. We don’t yet know how long this written representation would last, however, and we would like some clarification on any potential wording requirements.

For issuers who conduct multiple 506(c) offerings over time, the Commissioners believe that the new addition would reduce accredited investor verification costs. Investors would also benefit because they would not need to repeatedly submit financially sensitive information to the issuer for privacy reasons. If this newly proposed addition to Rule 506(c) goes through, investors will not need to repeat the accredited investor verification process multiple times for the same issuer. This may increase the number of Rule 506(c) offerings on the private placement market.

The SEC has also clarified that there are some other situations that may reduce the need for investor verification. In the documentation for the newly proposed rules, the Commissioners site Id. at Section II.B.3.a. which states: "…the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify accredited investor status, and vice versa." For instance, offerings requiring a high minimum investment amount may require fewer verification steps if the investor meets those terms without the use of third-party financing.