The Process of Verifying Investors in a Rule 506(c) Offering

Many companies that raise funds for projects depend on the Rule 506(c) of Regulation D exemption when offering securities. These firms have a number of options for verifying the accredited investor status of prospective investors. Until 2013, most security offerings depended on Rule 506(b) in order to avoid registering with the Securities and Exchange Commission (SEC). Rule 506(b) gives investors the ability to verify themselves through the completion of a questionnaire. The 506(c) verification process was not as familiar to founders as the 506(b) process.

Rule 506(c) and Reasonable Steps
One of the major catch for issuers who wish to use Rule 506(c) is following the requirement to take “reasonable steps” to verify the accredited status of each investor. The most direct way to fulfill this requirement is to use one of the designated methods provided in Rule 506(c) – called a safe harbor. By using one of these methods, the issuer is deemed to have fulfilled the reasonable steps necessary to verify the status of an accredited investor. Generally speaking, there are three ways to conform to a Rule 506(c) safe harbor. These include:

  • When the status of the accredited investor is based on net worth, the issuer needs to look over certain documents that show the investor’s assets and liabilities cover the previous 3 months, including a consumer report of liabilities. The issuer must also obtain a representation from the investor in written form that they have made known all liabilities required to make a proper net worth determination.
  • When the status of an accredited investor is based on income, the issuer will need to review IRS forms (not including certain foreign investor related forms) that show the income of the investor over the previous two years, and also a written confirmation that the investor is able to obtain the same level of income in the current year.
  • Alternatively, the issuer can get a written confirmation from a CPA, a licensed attorney, SEC-registered investment adviser, or registered broker-dealer verifying the investor is an accredited investor. In general, the required evidence should be no older than 90 days.

To sum up, an issuer can utilize one of the three safe harbors and meet the requirements of Rule 506(c).

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