506(b) Verifications vs. 506(c) Verifications of Investor Accredited Status

by | Mar 11, 2024 | Financial Services

When it comes to soliciting investments, startups and businesses must follow the specific regulations set forth by the Securities and Exchange Commission (SEC). Two prominent regulations, Rule 506(b) and Rule 506(c), govern how issuers verify the accredited status of investors. Understanding the distinctions between Rule 506(b) verifications and 506(c) verifications is crucial for compliance and successful capital-raising efforts.

Rule 506(b) Accredited Investor Verification

Under Rule 506(b), issuers have the flexibility to accept an investor’s claim of accredited status without engaging in a rigorous verification process. This rule allows companies to raise funds from an unlimited number of accredited investors and up to 35 non-accredited investors. Moreover, there are no limitations on the amount of capital that can be raised.

However, while Rule 506(b) offers streamlined procedures, issuers should still exercise caution. Implementing a thorough screening process for 506(b) verifications, such as utilizing questionnaires, can reduce the risks associated with non-accredited investors slipping through the cracks. Failure to comply with the required accredited status verification may render the securities offering illegal, prompting the SEC to exercise regulatory action.

Outsourcing accredited investor verification to third-party services provides a cost-effective solution for businesses seeking to comply with Rule 506(b) requirements. These services streamline the verification process, ensuring adherence to regulatory requirements while lessening the burden on issuers.

Rule 506(c) Accredited Investor Verification

In contrast to Rule 506(b), Rule 506(c) requires a more stringent verification process for accredited investors. Issuers must perform “reasonable steps” to verify the accredited status of investors solicited under this rule. The SEC’s principles-based approach requires issuers to objectively evaluate the adequacy of verification measures based on individual circumstances.

The safe harbors established in Rule 506(c) allow for multiple accredited investor verification methods, which include income review, asset assessment, and professional certification. While these methods provide flexibility, they can be onerous for both issuers and investors, particularly with recurring investments that require periodic updates.

To address these challenges, investor verification services have come on the scene, offering streamlined solutions for verifying the accredited status of investors. These services ease the administrative burden associated with regulation compliance, allowing issuers to focus on capital-raising efforts without violating regulatory requirements.

Navigating Rule 506(b) verifications and Rule 506(c) verifications of accredited investor status demands a nuanced understanding of regulatory requirements and compliance responsibilities. While Rule 506(b) offers flexibility in verification procedures, Rule 506(c) imposes stricter standards to ensure investor accreditation. By leveraging third-party verification services and adhering to regulatory guidelines, startups, and other companies can strengthen investor confidence and enable successful fundraising initiatives that comply with SEC regulations.

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