On March 12, 2025, the SEC's Division of Corporation Finance
issued a no-action letter
providing interpretive guidance with respect to the requirement to
verify a purchaser's accredited investor status in a Rule
506(c) offering under Regulation D.
In the no-action letter, the Staff agreed that an issuer offering
securities under Rule 506(c) could reasonably rely on
self-certifications from investors as to their accredited investor
status if they meet certain minimum investment requirements. This
no-action letter has the potential to significantly broaden
opportunities for private funds and other businesses to raise
capital from prospective investors.
Background
The U.S. Securities Act of 1933 (Securities Act) generally
requires issuers to register U.S. offerings of securities. Section
4(a)(2) of the Securities Act provides an exemption from
registration for securities issued in "transactions not
involving any public offering." Rule 506 of Regulation D is a
non-exclusive safe harbor under Section 4(a)(2); offers and sales
of securities satisfying the conditions of the rule are exempt from
such registration as "transactions not involving any public
offering." From the time of its adoption in 1982 and
consistent with the nature of the Section 4(a)(2) exemption, Rule
506 provided that it was unavailable to securities offered or sold
"by any form of general solicitation or general
advertising." This prohibition under Rule 506(b) can
significantly hinder an issuer's ability to raise capital,
especially for newer market entrants, such as sponsors that are
seeking to raise first-time investment funds, who do not have
existing relationships with prospective investors.
In 2012 Congress enacted the JOBS Act,1 in which it
directed the SEC to amend Rule 506 to provide that "the
prohibition against general solicitation or general advertising . .
. shall not apply to offers and sales of securities made pursuant
to [Rule 506], provided that all purchasers of the securities are
accredited investors" and subject to a requirement that the
issuer "take reasonable steps to verify that purchasers of the
securities are accredited investors, using such methods as
determined by the [SEC]." The SEC responded by bifurcating the
Rule 506 exemption. Rule 506(b) is the old version of the rule,
while Rule 506(c) contains the modifications required by the JOBS
Act: elimination of the prohibition on general solicitation or
advertising, a requirement that all purchasers of the securities be
accredited investors,2 and the new verification
requirement. Rule 506(c)(2)(ii) includes a "non-exclusive and
non-mandatory" list of acceptable verification procedures,
which generally require obtaining documentation or information from
third parties, including a review of W-2s or 1099s, tax returns,
bank or brokerage statements, or similar items.
However, Rule 506(c) has not been a great success. Far more capital
is raised in Rule 506(b) offerings than in Rule 506(c) offerings,
probably reflecting the administrative burden and increased risk on
issuers and their placement agents created by the verification
requirement and the potential reluctance of purchasers to provide
the required documentation.
The New Guidance
In the no-action letter, the Staff expressed its approval of a
more streamlined approach to the verification requirement based on
the amount of each purchaser's investment and without requiring
any documentation from third parties. As the SEC noted in the
adopting release for Rule 506(c),3 if a purchaser is
able to meet a required high minimum investment amount, the
likelihood that such purchaser will satisfy the accredited investor
definition may be high enough that "absent any facts that
indicate that the purchaser is not an accredited investor, it may
be reasonable for the issuer to take fewer steps to verify or, in
certain cases, no additional steps to verify accredited investor
status other than to confirm that the purchaser's cash
investment is not being financed by a third party."
The no-action letter accepts minimum investment amounts of $200,000
for purchasers that are natural persons and $1,000,000 for
purchasers that are entities as satisfying this
standard4 if accompanied by written representations from
the purchaser that: (i) such purchaser is an accredited investor
under applicable definitions, and (ii) such purchaser's minimum
investment amount (and, for purchasers that are legal entities
accredited solely from the accredited investor status of all of
their equity owners, the minimum investment amount of each of the
purchaser's equity owners) is not financed in whole or in part
by any third party for the specific purpose of making the
particular investment in the issuer.
The Staff noted that the Rule 506(c) exemption would not be
available if the issuer had actual knowledge of any facts
indicating that any purchaser is not an accredited investor, or
that the minimum investment amount of any purchaser (and, for
purchasers that are legal entities accredited solely from the
accredited investor status of all of their equity owners, the
minimum investment amount of any such equity owner) is financed in
whole or in part by any third-party for the specific purpose of
making the particular investment in the issuer.
The no-action letter response concluded by stating that whether an
issuer has taken reasonable steps to verify that a purchaser is an
accredited investor is an objective determination by the issuer (or
those acting on its behalf), in the context of the particular facts
and circumstances of each purchaser and transaction, but expressed
the Staff's agreement with the view that an issuer could
reasonably conclude that satisfaction of the criteria described
above meant that it has taken reasonable steps to verify accredited
investor status for purposes of Rule 506(c). Of course, because the
Staff's views are based on the representations set forth in the
no-action letter, any different facts or conditions might require
the Staff to reach a different conclusion.
New York State Securities Laws
Under New York's Martin Act, a transaction conducted under Rule 506(c) may be considered tantamount to an offering made to the public if it involves general solicitation or advertising. This in turn will require compliance with the Martin Act's filing provisions if the issuer is based in New York, or residents of New York will be offered the opportunity to participate in the offering.
Footnotes
1 Jumpstart Our Business Startups Act, Public Law No: 112-106 (Apr 5, 2012).
2 Rule 506(c)(2)(i). Rule 506(b) permits up to 35 purchasers who are not accredited investors.
3 Securities Act Release No. 33-9415.
4 In the case of an entity that is an accredited investor solely because all of its equity owners are accredited investors these minimum amounts would apply to the investment of each equity owner. Of particular significance to issuers that are private equity or other investment funds, amounts subject to a contractual commitment to invest when called by the issuer are included in an investors investment amount for purpose of satisfying the minimum.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
