A Brief Overview of the Reasonable Steps Verification Requirement Under Rule 506(c)

by | Mar 11, 2024 | Financial Services

Rule 506(c) of Regulation D, established by the Securities and Exchange Commission (SEC), offers private companies the opportunity to advertise and generally solicit potential investors. However, to qualify under this rule, issuers must adhere to the reasonable steps verification requirement, ensuring that investors meet the accredited investor criteria delineated by the SEC.

Importance of Rule 506(c)

Historically, the SEC prohibited general solicitation and advertising of offerings. However, the passage of the JOBS Act in 2012 introduced Rule 506(c), enabling issuers to publicly market their offerings exclusively to accredited investors, thereby expanding capital-raising opportunities for startups.

Mechanics of Rule 506(c)

Under Rule 506(c), issuers can solicit and advertise offerings, provided that:

  • All purchasers are accredited investors.
  • The issuer takes reasonable steps to verify the accredited investor status of purchasers.
  • Other conditions outlined in Regulation D are met.

Reasonable Steps Verification Requirement

The reasonable steps verification requirement necessitates that issuers objectively determine the adequacy of their verification methods based on the specific circumstances and facts of each purchaser and transaction. While Rule 506(c) provides a non-exhaustive list of verification methods, issuers have the flexibility to define and hone their approach to the unique characteristics of their offerings and investors.

Verification methods include reviewing IRS forms (e.g., Form W-2, Form 1099, Form 1040, and Schedule K-1) for the past two years to verify income. Examining credit reports, bank statements, and appraisals through real estate professionals determines net worth. Hiring a third-party accredited investor verification service, licensed professional, or attorney provides written confirmation of accreditation.

Ensuring Diligence in Verification

Issuers must remain vigilant in adhering to proper verification protocols. Although the SEC emphasizes a principles-based approach, issuers should exercise due diligence to ensure compliance and mitigate risks associated with non-compliance.

The reasonable steps verification requirement under Rule 506(c) plays a key role in facilitating the formation of capital and investment opportunities for startups and private companies. By adhering to regulatory standards and leveraging amended provisions, issuers can successfully navigate the intricate landscape of accredited investor verification while promoting growth and innovation in the marketplace.

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