This post was written by Robert K. Morris.
One of the goals of the federal JOBS Act, enacted in 2012, was to expand the ability of companies (both operating companies and funds) to make non-registered securities offerings using general solicitation and advertising. Offers made through general solicitation and advertising have been prohibited under the SEC’s private offering safe harbor ever since Regulation D was adopted in 1982, and many have complained that the restriction was pointless where all purchasers were accredited investors as defined in Regulation D. However, the SEC believed a change required legislation.
The JOBS Act made that change. However, the Act, and the new rule adopted in 2013, imposed a new requirement – the issuer of the securities must take reasonable steps to “verify” that all the purchasers in a general solicitation offering are accredited investors. Failure to take reasonable verification steps would violate the rule even if it turned out that all purchasers actually were accredited.
For an individual to be an accredited investor, he or she must have net worth excluding principal residence of at least $1 million, or net income of $200,000 ($300,000 with spouse) in each of the two most recent years and a reasonable expectation of achieving the same in the current year. Under the new rule, reasonable steps by the issuer to verify these criteria would include reviewing tax returns, bank statements, brokerage statements and consumer reports from recognized agencies. To date, these steps have not seen significant use, as issuers have found them burdensome, and investors have asserted privacy concerns. Critically, the SEC has made it clear that an issuer may not simply rely on the investor’s own representation that he or she is an accredited investor.
The new rule permits an issuer to rely on a confirmation by a registered broker-dealer or investment adviser that it has taken reasonable steps to verify the accredited investor. While this route offers the potential advantage of easing the burden on the issuer and the privacy concerns of the investor (particularly one with a pre-existing relationship with the broker-dealer/investment adviser), it hinges on the willingness of the broker-dealer/investment adviser to provide the confirmation.
In June, the Securities Industry and Financial Markets Association (SIFMA) published guidance for its members in providing such confirmations. Although the guidance does not carry the force of law, and is not legal advice, as a practical matter, broker-dealers and investment advisers may derive comfort from it, increasing their willingness to provide verifications to issuers. The guidance is accompanied by a statement of 20 leading law firms stating their belief that the SIFMA guidance is reasonable for registered broker-dealers and investment advisers to apply.
Under the guidance, the broker-dealer/investment adviser may generally verify an investor as accredited if the investor has a six-month relationship with the verifier, and has an account balance of at least $2 million. SIFMA concludes from economic analysis that it is reasonable to assume that such a person would not have liabilities in excess of $1 million and would thus satisfy the $1 million net worth test for accredited investor status. Alternatively, SIFMA states that a verifier with such a relationship with the investor could verify if the investor invests at least $250,000 and represents that he or she has a net worth of at least four times the investment.
Many market participants seek legal opinions that no registration is required for the sale of securities in the Regulation D offering. For general solicitation to be used, counsel will need to conclude that the accredited investor verification requirement has been met. This conclusion may now be possible where verification is provided by a registered broker-dealer or investment adviser in accordance with the SIFMA guidance.