The Division of Corporation Finance of the U.S. Securities and Exchange Commission (“SEC”) recently issued new interpretive guidance (the “Staff Guidance”) that provides helpful clarity for private fund issuers seeking to utilize the general solicitation safe harbor under Rule 506(c) of Regulation D of the Securities Act of 1933 (“Securities Act”), as amended.
Background
In recent years, private fund issuers have increasingly relied on Rule 506(c) of Regulation D under the Securities Act to raise capital. This rule allows issuers to engage in general solicitation and advertising, provided that all purchasers in the offering are verified as accredited investors, and that the issuer takes reasonable steps to confirm their status. However, the requirement to verify accredited investor status has often posed practical challenges, particularly in striking a balance between thorough compliance and an efficient capital raise. Issuers have faced uncertainty around what constitutes “reasonable steps,” leading many to adopt overly conservative verification methods or to forgo Rule 506(c) altogether in favor of more familiar, but more restrictive, exemptions. In response to this landscape, this Staff Guidance offers a more flexible approach, specifically where a high minimum investment threshold is used in a securities offering.
Summary of Staff Guidance
Under this guidance, issuers may have greater flexibility in verifying the accredited investor status of purchasers. The Staff Guidance acknowledges that there are certain factual scenarios where the likelihood of a purchaser being accredited is high enough that a simplified verification approach may be reasonable. Specifically, the guidance focuses on offerings that require a high minimum investment amount. In such cases, if an investor is able to meet the minimum investment threshold using their own funds, and there are no facts suggesting the investor is not accredited, the SEC staff indicates that an issuer may reasonably conclude that fewer steps are required to verify their status.
Importantly, this doesn’t eliminate the need for verification altogether. Instead, it reframes how an issuer might approach the process based on the nature of the offering and the investor’s profile. For example, the issuer would still need to confirm that the investment is not being financed by a third party, as leveraging outside funds could undermine the assumption that the investor has sufficient financial means to qualify.
Key Conditions for Reliance
While the SEC’s Staff Guidance opens the door to a more flexible approach in verifying accredited investor status, this flexibility is not without structure. The guidance outlines specific conditions that issuers must satisfy in order to reasonably rely on the high minimum investment threshold as a basis for streamlined verification under Rule 506(c).
First and foremost, written representations from each investor are required. These representations must confirm two critical points:
- That the investor qualifies as an accredited investor under the relevant provisions of Regulation D, and
- That the investors’ investment is not financed, either in whole or in part, by any third party for the purpose of making the specific investment in the issuer’s offering.
Second, the issuer must have no actual knowledge of any facts that would put the accredited investor status into question. This includes any indication that the investment is being made with borrowed funds or that the investor otherwise fails to meet the financial or professional qualifications defined under Rule 501(a).
Key Action Items
- Issuers should consult legal counsel to evaluate how this Staff Guidance may affect the structuring, documentation and marketing of current and upcoming offerings.
- Broker-dealers are advised to review and, if necessary, update their internal compliance procedures and selling agreements, especially where ongoing securities offerings rely on the Rule 506(c) exemption.
Takeaway
By recognizing that a high minimum investment can be a strong indicator of an investor’s financial sophistication, the SEC has created a pathway for issuers to conduct offerings more efficiently, particularly when targeting high-net-worth individuals or institutional investors. However, with that said, the flexibility offered by this guidance does not eliminate the need for diligence. Issuers and broker-dealers must remain attentive to red flags, properly document investor representations, and avoid any actual knowledge that would conflict with an investor’s claimed status.