The Primerus Paradigm - Winter 2014 Page 23

W I N T E R 2 0 1 4

Are there any safe harbor methods
to verify accredited investors status?

Although the SEC guidance above is ex-
tremely vague, Rule 506(c) contains four
specific methods of verifying accredited
investor status. These methods, if used,
are deemed to satisfy the verification
requirement contained in Rule 506(c).
However, companies are not required
to use the safe harbor methods and can
use the general reasonableness standard.
Below is a brief summary of the four safe
harbor methods:

· Income Verification.

To verify the

income of an investor, a company can
obtain copies of IRS forms from the
past two years that report income,
including Form W-2, Form 1099,
Schedule K-1, and a filed copy of
Form 1040. A representation from
the investor regarding current income
should also be obtained.

· Net Worth Verification.

To verify the

net worth of an investor, a company
can obtain items such as bank state-
ments, brokerage statements, tax
assessments and appraisal reports
dated within the last three months
and obtain a representation from
the investor concerning liabilities.
Documentation of liabilities must also
include a credit report from at least
one of the major credit agencies.

· Confirmation from Third Party.

Instead of the first two options above,
a company may obtain a written
confirmation of an investor's accred-
ited investor status from a registered
broker-dealer, an SEC registered in-
vestment advisor, a licensed attorney,
a certified public accountant and,
possibly, a third party certification
service. The representation should in-
dicate that the third party has, within
the previous three months, taken
reasonable steps to verify that the
investor is accredited.

· Prior Investor.

A company is deemed

to have complied with the verification
requirement if an investor who previ-
ously invested in a company's prior
offering under Rule 506 invests in a
subsequent offering and certifies that
the investor continues to qualify as an
accredited investor.

Although these safe harbors are
helpful, it is unfortunate that the SEC
required the use of a credit report with
respect to verifying net worth. We believe
that few investors will agree to provide
a credit report. It is also burdensome
to require re-certifications of net worth
every three months. Finally, some
investors will be reluctant to provide
specific information regarding their
income. Therefore, we believe that third
party confirmation will likely become
the most utilized of the safe harbor
verification methods.

Are there any restrictions on the
content of advertising or solicitation
methods?

Although the SEC has issued

a proposed rule requiring legends in
advertising materials, it is unclear
whether this rule will be finalized and
there is currently no specific guidance
regarding advertising content or
solicitation methods. Nevertheless,
companies should use common sense
in developing advertisements and in
determining the methods of general
solicitation.
Legends similar to the legends
described in the SEC's proposed rule
should be included in any written
advertising or communications.
Additionally, companies should not make
statements that cannot be substantiated
and should avoid statements regarding
future performance. Misleading
information contained in advertisements
could subject a company to claims from
investors and securities regulators for
violation of anti-fraud rules. Finally,
other laws may impose restrictions

on certain types of solicitations. For
example, there are restrictions on phone
and email solicitations under various
state and federal laws. Also, if the
company will be utilizing broker-dealers,
the Financial Industry Regulatory
Authority (FINRA) imposes specific
rules regarding advertising content.

Are there any other limitations?

The

SEC issued rules in July that prohibit
certain felons and other "bad actors"
(and companies where these individuals
have a significant ownership interest
or control rights) from participating in
securities offerings under Rule 506.

This will require a significant amount of
pre-offering due diligence on the part of
companies and their counsel to ensure
that principals of the company are not
subject to such restrictions.
Finally, the SEC issued proposed
rules with several other requirements.

Although these proposed rules contain
additional burdensome requirements
(including pre-submission of general
solicitation materials to the SEC), the
proposed rules have not been finalized
and it is unclear whether the rules will
be finalized in their current form.

1 The "Jumpstart Our Business Startups Act" can be

found at: www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/
pdf/BILLS-112hr3606enr.pdf

2 The SEC's final rule can be found at: www.sec.gov/

rules/final/2013/33-9415.pdf

3 Note that "old" Rule 506 (now Rule 506(b)) is still

available to companies who do not need to utilize gen-
eral solicitation or advertising. We believe that many
companies will continue to use Rule 506(b) because it
is less burdensome than Rule 506(c).

4 The definition of "accredited investor" can be found at

17 CFR §230.501.

5 Note that this restriction applies to both Rule 506(b)

and Rule 506(c) offerings. The SEC's final rule regard-
ing bad actors can be found at: www.sec.gov/rules/
final/2013/33-9414.pdf

6 The SEC's proposed rule containing additional

requirements can be found at: www.sec.gov/rules/pro-
posed/2013/33-9416.pdf