The Securities Industry and Financial Markets Association (SIFMA) issued a memorandum (the “Memorandum”) with guidance for registered broker-dealers and investment advisers on various non-exclusive means of verifying an investor’s accredited investor status so as to have a basis for submitting a written confirmation of that determination to an issuer seeking to rely on the private offering exemption in Rule 506(c) of Regulation D under the Securities Act of 1933 (the “Securities Act”). Rule 506(c) provides four non-exclusive safe harbor methods for an issuer to meet the requirement that it take “reasonable steps” to verify that all purchasers in a Rule 506(c) offering are accredited investors. (See the June 23, 2013 Financial Services Alert for a more detailed discussion of Rule 506(c).) The Memorandum recognizes that two of the safe harbors may be not be attractive to purchasers who may not wish to provide personal financial information about their annual income or the amount of their assets and liabilities. In order to facilitate reliance on the safe harbor method that permits an issuer to rely on a written confirmation of a purchaser’s accredited investor status provided by a registered broker-dealer, registered investment adviser, licensed attorney, or certified public accountant, when that party has taken reasonable steps to verify the purchaser’s accredited investor status before providing the confirmation, the Memorandum outlines reasonable steps that registered broker-dealers and investment advisers may take to verify the purchaser’s accredited investor status, while noting that the guidance in the Memorandum may also be useful to issuers and other market participants. This article provides a brief summary of the methods discussed in the Memorandum, which provides important additional detail on the various elements of each method.
Verification - Natural Persons
Account Balance Method. SIFMA believes that a broker-dealer or investment adviser will have taken reasonable steps to verify that its client meets the net worth test for accredited investor status (generally, individual net worth (or joint net worth with spouse) in excess of $1 million, not including primary residence) if (i) the client (a) has had an account with the firm for at least six months, (b) has (individually or jointly with the client’s spouse) at least $2 million in cash and marketable securities in the account prior to making the investment in the Rule 506(c) offering (net of any amounts borrowed to purchase securities on margin) and (c) has provided the representations in the form of accredited investor questionnaire attached to the Memorandum (the “Purchaser Representations”), including the representation that the client has not borrowed or guaranteed any business loans other than those disclosed to the firm; and (ii) the firm is unaware of facts indicating that the client is not an accredited investor. The $2 million threshold reflects an assumption that the client has $1 million of liabilities. (The basis for this assumption is discussed in more detail in the Memorandum.) The Memorandum instructs that if the client has made any business loans or guarantees of business loans or drawn on a personal line of credit, and the amount of these obligations exceeds the fair value of the client’s assets posted as collateral, then the $2 million threshold should be increased by that excess amount.
Investment Amount Method. SIFMA believes that a broker-dealer or investment adviser will have taken reasonable steps to verify its client’s accredited investor status under the net worth test if (1) the client (a) has been with the firm for at least six months, (b) (i) invests at least $250,000 in the Rule 506(c) offering or (ii) makes an unconditional commitment, callable in whole at any time, to invest at least $250,000 in the Rule 506(c) offering, and (c) has provided the Purchaser Representations, including the representation that the proposed investment is less than 25% of the client’s net worth (individually or jointly with the client’s spouse), (2) the firm is unaware of facts indicating that the client is not an accredited investor and (3) in the case where the client is making a capital commitment, the firm has knowledge that the client has fulfilled a call under a prior commitment.
Verification - Legal Entities
Accredited Investor Based on Entity Type. If a legal entity claims to qualify as an accredited investor because it is one of various types of entities specifically identified as such in Regulation D (e.g., because it is a bank, an insurance company, or a registered broker-dealer), SIFMA believes that verification of that qualification at least annually will constitute reasonable steps to verify accredited investor status absent any facts indicating a change in status. The Memorandum does not specify how to verify accredited investor status for these types of entities except to note that a broker-dealer or investment adviser’s registration with the SEC can be verified on the FINRA’s BrokerCheck website.
Accredited Investor Based on Entity Type and Assets. If a legal entity claims to qualify as an accredited investor on the basis of a combination of entity type and assets (e.g., because it is a 501(c)(3) organization, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000), SIFMA believes that a person will have taken reasonable steps to verify the entity’s accredited investor status if (a) it confirms that the entity is named on a broker-dealer’s or investment adviser’s current list of clients that qualify as “institutional accounts” as defined in FINRA Rule 4512(c)(3)22 or as Qualified Institutional Buyers as defined in Rule 144A under the Securities Act (which are required to have investible assets of at least $100 million), or (b) the entity makes an investment in the Rule 506(c) offering in excess of $5 million and the entity provides a written representation that it was not formed for the purpose of making that investment and has made at least one prior investment in securities (whether in a primary offering or in the secondary market).
Law Firm Support
Exhibit C to the Guidance lists law firms, including Goodwin Procter, that believe that the procedures in the Memorandum provide reasonable guidance for registered broker-dealers and investment advisers to apply in their particular circumstances.