SEC EASES INVESTOR VERIFICATION BURDEN IN RULE 506(C) OFFERINGS
On March 12, 2025, the U.S. Securities and Exchange Commission (the “SEC”) issued new interpretive guidance on verifying an investor’s “accredited investor” status under Rule 506(c) of Regulation D of the Securities Act of 1933 (the “Securities Act”), significantly impacting the fundraising process for private companies and funds.
Legal Background
Regulation D of the Securities Act provides certain safe harbors which allow private companies and funds to raise capital from outside investors, without the need to register the offering with the SEC.
The most frequently used of these safe harbors is Rule 506(b), that allows private companies and funds to raise an unlimited amount of capital from outside “accredited investors” and a limited number of nonaccredited investors. However, Rule 506(b) prohibits general solicitations for investment, limiting private companies’ access only to investors with whom they hold a pre-existing relationship.
In an attempted response to this limitation came Rule 506(c), as part of the United States’ “Jumpstart Our Business Startups Act” of 2012, which allowed private companies and funds to raise an unlimited amount of capital from investors through general solicitation of outside investors. However, Rule 506(c) required that all investors in a Rule 506(c) private offering be an “accredited investor”.
An “accredited investor” is defined under Rule 501(a) of the Securities Act. Investors typically qualify as an accredited investor as (i) an individual with an income exceeding $200,000 a year (or $300,000 if married, filing jointly), (ii) an individual with a personal or joint net worth exceeding $1,000,000 in value (excluding the value of their primary residence), or (iii) an entity owning assets or investments in excess of $5,000,000.
Under Rule 506(c), the offering issuer is required to take “reasonable steps to verify” each investor’s accredited investor status. Prior to the SEC’s new interpretative guidance, taking reasonable steps to verify each investor’s accredited investor status was a burdensome process, requiring access to private financial material or obtaining written confirmation from third-party professionals. The SEC made clear that merely obtaining a written representation by the investor that they meet the criteria to be an accredited investor was not sufficient to constitute reasonable steps to verify.
Further, because of this requirement, utilizing Rule 506(c) was viewed as a risky proposition because, if an investor to the offering was determined not to be an accredited investor after the fact, the registration exemption would go away, and because the offering was not registered with the SEC, the offering would be a violation of the Securities Act, subjecting the issuer to fines and penalties.
Therefore, the ultimate effect of the verification process and related liability risk of Rule 506(c) was that it was less often used and, instead, private companies and funds opted to continue to utilize the less risky Rule 506(b).
SEC’s New Guidance
On March 12, 2025, the SEC issued a new interpretation of what constitutes “reasonable steps to verify” under Rule 506(c). Under the new guidance, the SEC acknowledged that an investor’s ability to provide a non-financed high investment in and of itself indicates accredited investor status.
Accordingly, the SEC has eased the burden of investor verification under Rule 506(c) by allowing third party investors to self-certify their accredited status if the following requirements are met:
The SEC will conclude that an issuer of a private offering under Rule 506(c) has taken reasonable steps to verify an investor’s accredited investor status if: (i) the minimum investment is at least $200,000 for an individual or $1,000,000 for an entity, and such amount is not financed by a third-party; (ii) the investor provides a written representation that they are an accredited investor under the definition of the Securities Act; and (iii) the issuer has no actual knowledge that the written representation provided by the investor is not true.
Effect of the New Guidance
This new guidance represents a major shift in procedures, signaling a more flexible and business-friendly approach to compliance for private fundraising efforts.
With the burdens and risks of Rule 506(c) potentially reduced, private companies and funds will enjoy a more efficient and less burdensome process to bringing on generally solicited outside investors by simply incorporating the required written representations of the investor’s accredited investor status into their subscription documents.
Read the full letter here: SEC 506(c) Interpretive Guidance
Dvorak Law Group’s securities and capital markets attorneys regularly represent issuers, underwriters, investors, investment funds, investment fund managers, investment advisers, and broker-dealers in a wide range of transactions. Our skilled and experienced securities and capital markets attorneys are able to effectively and efficiently guide clients through the complexities and intricacies of a transaction to advance their objectives and to help them comply with the applicable state and federal laws and regulations.
Author:
Aaron Jansen, Partner
Email: ajansen@ddlawgroup.com