Accredited Investor Verification: SIFMA Issues Guidance | Practical Law

Accredited Investor Verification: SIFMA Issues Guidance | Practical Law

SIFMA issued guidance for registered broker-dealers and investment advisers on suggested methods for verifying clients' accredited investor status for purposes of Rule 506(c) under the Securities Act.

Accredited Investor Verification: SIFMA Issues Guidance

Practical Law Legal Update 4-572-5325 (Approx. 4 pages)

Accredited Investor Verification: SIFMA Issues Guidance

by Practical Law Corporate & Securities
Published on 25 Jun 2014 • USA (National/Federal)
SIFMA issued guidance for registered broker-dealers and investment advisers on suggested methods for verifying clients' accredited investor status for purposes of Rule 506(c) under the Securities Act.
On June 23, 2014, the Securities Industry and Financial Markets Association (SIFMA) issued guidance for registered broker-dealers and investment advisers suggesting verification methods for use when these parties are asked to issue a written confirmation that one of their clients is an accredited investor (AI) for purposes of that client participating in a securities offering relying on Rule 506(c) under the Securities Act. The guidance states that it may also be useful to issuers and other market participants in Rule 506(c) offerings.
Rule 506(c), an amendment to Regulation D required by the JOBS Act, permits general solicitation and advertising to be used in offerings exempt from registration under Rule 506, subject to certain conditions. Among these conditions, each purchaser in the Rule 506(c) offering must be an AI and the issuer must take reasonable steps to verify that each purchaser is an AI.
Rule 506(c) includes several non-exclusive verification methods that an issuer may use to satisfy the reasonable steps standard under the rule with respect to prospective investors that are natural persons. One of these is the issuer obtaining a written confirmation from, among other types of third parties, a registered broker-dealer or investment advisor confirming that the third party has confirmed a prospective investor's AI status after taking reasonable steps to do so. The SIFMA guidance is primarily relevant to registered broker-dealers and investment advisers that prepare third-party verification confirmations:
  • With respect to their natural person clients as part of an issuer complying with this non-exclusive verification method.
  • Under analogous circumstances involving prospective investors that are entities rather than natural persons.

General Conditions for All Verification Methods

The verification methods suggested by the SIFMA guidance are premised on the notion that broker-dealers and investment advisers have access to certain information about their clients by virtue of the client relationships. In light of this, all the suggested verification methods require two general conditions to be met:
  • The client must have maintained an account with the broker-dealer or investment adviser for at least six months.
  • The client has represented in writing to the firm that it:
    • is not borrowing any money to make its investment in the proposed Rule 506(c) offering;
    • is making the investment for his or her own account or for a joint account with a spouse; and
    • is an AI.
The guidance includes a form of representation letter covering these points as well as other points the client may need to represent to in accordance with the specific verification methods discussed below.

Verification Methods for Natural Person Clients

The guidance suggests two separate verification methods a broker-dealer or investment adviser might take as reasonable steps to verify a natural person client's AI status:
  • The account balance method.
  • The investment amount method.
Under the account balance method, SIFMA believes that a broker-dealer or investment adviser will have taken reasonable steps to verify a client's AI status if, in addition to the general conditions:
  • The client has, before making the investment in the Rule 506(c) offering, at least $2 million in cash and marketable securities in its (individual or spousal joint) account with the firm, net of any amounts borrowed to purchase securities on the margin.
  • The client represents that it has not borrowed or guaranteed any business loans not disclosed to the firm.
  • The firm is not aware of any facts suggesting the client is not an AI.
Under the investment amount method, SIFMA believes that a broker-dealer or investment adviser will have taken reasonable steps to verify a client's AI status if, in addition to the general conditions:
  • The client invests, or unconditionally commits to fund, at least $250,000 in the Rule 506(c) offering.
  • The client represents that the proposed investment is less than 25% of the client's net worth (individually or with a spouse).
  • The firm is not aware of any facts suggesting the client is not an AI.
  • In the case of a commitment, the firm has knowledge that the client has fulfilled a call under an earlier commitment.

Verification Methods for Entity Clients

The guidance also suggests a verification method a broker-dealer or investment adviser might take as reasonable steps to verify an entity client client's AI status. Under this method:
  • Where a legal entity client qualifies as an AI on the basis of holding a status alone (for example, a bank), SIFMA believes a firm will have taken reasonable steps to verify its AI status if it verifies that the client holds the relevant status at least once a year (and absent any facts indicating a change in status).
  • Where a legal entity client qualifies as an AI on the basis of holding a status and having assets of over $5 million (for example, a corporation or trust), SIFMA believes a firm will have taken reasonable steps to verify its AI status if the client:
    • is named on a broker-dealer's or investment adviser's current list of clients that qualify as institutional accounts (as defined in FINRA Rule 4512(c)(3)22)) or qualified institutional buyers; or
    • makes an investment in the Rule 506(c) offering of more than $5 million and represents that it was not formed for the purpose of making that investment and has made at least one earlier investment in securities.
To learn more about Rule 506(c) offerings and third-party AI verification, see Practice Note, JOBS Act: Regulation D and Rule 144A General Solicitation Summary and Standard Document, Third-party Accredited Investor Verification Letter for a Rule 506(c) Offering.