Earlier this year I participated in a Vanderbilt Law Review En Banc forum offering advice to the SEC regarding implementation of the JOBS Act. My piece focused on the SEC proposed rule lifting the ban on general solicitation; yesterday the SEC released final rules on the subject. The deal is that now private firms can advertise under new 506(c) of Reg D if they take reasonable steps to verify that any actual purchasers are in fact accredited.
What exactly are "reasonable steps?" There's the rub. The final rules track the proposed ones closely, save that the agency heeded the pleas of many, myself included, to articulate some concrete methods as to what constitutes a "reasonable step." I asked for a safe harbor, but the SEC declined to go so far.[Upon review, these methods are "deemed to satisfy the verification requirement, which sounds like a safe harbor to me.]
Here are the new, non-exclusive methods for an issuer to verify an investor's accredited status, along with my comments (for those not in the area, to qualify as an accredited investor you need to have income of over $200,000 ($300,000 joint) for the past 2 years, plus a reasonable expectation of the same in the current year) or $1 million net worth, excluding primary residence:
1. natural person income test:
- review of any forms filed with the IRS that report income, including a W-2, 1099, K-1, or 1040, for the past 2 years
- plus a written representation that the individual (and spouse, if applicable) reasonably expects to reach the income threshold for the current year.
- UR comment: seems pretty straightforward and reasonable.
- UR comment 2: the SEC suggests that a person could redact the form to avoid disclosing personally identifiable information like one's SSN. A good idea, especially since I'm concerned about scammers duping eager accredited investors with fake investment opportunities.
2. natural person net worth test:
- review of documents no more than 3 months old that verify assets, including: bank statements, brokerage statements and other statements of securities holdings, CDs, tax assessments and independent third-party appraisal reports
- plus for liabilities, a credit report from at least one national agency
- plus a written representation that all liabilities have been disclosed.
- UR comment: This was always the tricky one. Net worth is so easy to game--just disclose your assets and keep mum about your liabilities. There are still a lot of problems here: how do you know the third-party appraisals really are independent? What if forms are doctored? I know very little about what credit reports cover, but I'm sure there are large categories of liabilities they don't capture. I don't have any answers, but this method seems almost certain to cause problems down the road. If I were an issuer I would avoid it like the plague.
3. third-party verification method:
- written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a CPA that the individual has after taking reasonable steps determined within the past 3 months that the purchaser is an accredited investor.
- UR comment: I advocated for this approach, and I like it. It risks creating a "cottage industry" of third-party verifiers, but the odds are that most accredited investors already share their financial information with one of these professionals, so it probably won't slow things down much. I wouldn't be surprised if a lot of issuers plump for this path, in effect outsourcing their duty to take reasonable steps to verify accredited investor status.
- If a natural person invested in an issuer's Rule 506(b) offering prior to July 10, as long as they remain an investor, written confirmation of accredited status at sale suffices.
I started my En Banc piece with a hypothetical late-night infomercial-type scenario that I thought was pretty fanciful, but truth is apparently stranger than legal scholarship. The WSJ tells of entrepreneurs looking to use billboards, social media, and the products themselves as advertising. For example, a startup that converts shipping containers into portable produce gardens plans to cover one side of the 40-by-9-foot containers with billboard-style ads. Another plans to use ads on buses and in newspapers, plus hire people to wear T-shirts with the message, "especially window washers, because the skyscrapers they clean could have wealthy executives inside."
As I have written about, we're in a brave new world of private firms advertising to the general public. I've predicted that people will get upset as they realize that all of these exciting sounding opportunities are only available to the accredited investor. Securities law's dirty little secret--that the wealthy have special investment opportunities average Joes lack--may not be a secret much longer.
Update: Commissioner Aguilar disagrees with the new rule, worrying about investor protection.
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