When raising capital through private offerings under Regulation D, Rule 506(b) provides issuers with an exemption from SEC registration requirements. However, even though Rule 506(b) does not explicitly mandate investor verification, issuers still need to follow best practices to ensure that they are only offering securities to accredited investors and stay compliant with SEC guidelines. A well-documented investor verification process helps reduce risks associated with potential audits and ensures that the offering remains within the legal boundaries. Below is a comprehensive checklist for issuers to follow when verifying investor accreditation under Rule 506(b).
1. Understand the Definition of an Accredited Investor
Before initiating any verification steps, it is essential for issuers to fully understand what qualifies an investor as accredited under the SEC’s definition. According to the SEC, an accredited investor must meet certain income or net worth criteria or possess specific professional qualifications, among other methods. The key categories include:
- Individuals with an annual income of $200,000 USD (or $300,000 USD with a spouse or spousal equivalent) in each of the last two years and the expectation of exceeding the same income level.
- Individuals with a net worth exceeding $1 million USD, excluding the value of their primary residence.
- Certain institutional investors, such as banks or large tax-exempt organizations.
2. Collect Documentation to Support Investor’s Accredited Status
Under Rule 506(b), while attorney-based thorough verification is not mandatory, issuers should still collect and review supporting documentation to confirm that investors meet the accredited status. Common documents used to verify accredited investor status include:
- Income Verification: Tax returns, W-2 forms, or pay stubs to substantiate income claims.
- Net Worth Verification: Bank statements, brokerage account statements, or a letter from a licensed professional (such as a licensed attorney or CPA) confirming that the investor meets the accredited investor requirements.
- Professional Certifications: If an investor qualifies based on professional credentials (such as a Series 7, Series 65, or Series 82 license), the reviewer should request proof of those qualifications.
3. Rely on Investor Self-Certification
With Rule 506(b) issuers often use self-certification as an additional layer of documentation. This involves having investors sign a statement confirming their accredited status. While self-certification is not a substitute for other verification methods, it serves as a formal acknowledgment from the investor that they meet the SEC’s requirements.
4. Record-Keeping and Documentation Retention
Issuers must maintain detailed records of the verification process for each accredited investor. This documentation should include:
- Copies of any financial documents reviewed, such as tax returns or bank statements.
- A copy of the investor’s self-certification statement, if applicable.
- Notes or a log detailing the steps taken to verify the investor’s accredited status.
These records should be retained for a reasonable period, typically no less than five years, as the SEC may request this documentation in case of an audit or inquiry.
5. Periodic Review of Investor Verification Process
The SEC’s requirements and market conditions can evolve over time. As such, issuers should periodically review their verification procedures to ensure compliance with any changes to the rules or best practices. This is particularly important when raising capital through subsequent offerings or re-verifying the status of investors in future rounds of funding.
6. Consider Using a Third-Party Verification Service
While Rule 506(b) does not require formal third-party verification, many issuers choose to engage third-party services to verify accredited investor status. These services can help streamline the verification process by professionally reviewing investor documentation and providing an additional layer of confidence in compliance.
Although Rule 506(b) offers flexibility regarding investor verification, it is still critical for issuers to maintain a robust and compliant verification process. By understanding the definition of accredited investors, collecting the appropriate documentation, and keeping detailed records, issuers can reduce compliance risks and ensure that they meet SEC guidelines. Whether relying on self-certification or engaging a third-party verification service, issuers should take all necessary steps to protect their offering and ensure they remain compliant throughout the fundraising process.
