To gain accredited investor status, you must satisfy certain criteria established by the SEC, such as those pertaining to net worth, income, certain affiliations, or level of knowledge. Under Regulation D, Rule 506(c), the issuer of securities is responsible for verifying the status of their potential investors as accredited, as opposed to non-accredited. This is to be done by the issuer taking “reasonable steps” to verify the investors’ status. Reasonable steps verification is a step up from the lower standard of proof required under Rule 506(b) referred to as “reasonable belief.”
An issuer may use one of the following methods to perform reasonable steps to verify the accredited status of an investor:
1. Knowledgeable Individual Method
Individuals with the position of general partner, executive officer, or director for the issuer of securities qualify as accredited investors. The issuer should be able to verify the positions of these individuals or reference internal publicly available information that provides the verification.
2. Net Worth Method
The issuer can perform reasonable steps verification of the investor’s status as accredited by obtaining documentation from the investor that reveals their net worth as greater than $1 million USD (not including the value of the investor’s primary residence). This involves reviewing documentation provided by the investor that shows the investor’s assets and liabilities, such as IRS forms, credit reports, real estate ownership documents such as tax bills, proof of vehicle ownership, value of private company securities holdings, and third-party valuation of property holdings.
3. Income Method
The issuer may also perform reasonable steps verification by verifying that the investor exceeds the income criteria established by the SEC – $200,000 USD alone or $300,000 USD with a spouse or spousal equivalent– with the reasonable expectation of matching or exceeding that income level in the coming year. Verifying based on income involves obtaining documents from the investor that prove the income thresholds have been met, such as IRS forms (1040s, W-2s, 1099s, K-1s, etc.), pay stubs, tax filings, or a letter from an employer or accountant that confirms the investors actual or expected yearly income.
Third-Party Verification
Rule 506(c) permits another method of carrying out reasonable steps verification that reduces the complexity and time-consuming nature of the methods mentioned above. This involves using third-party verification.
As opposed to the manual process of reviewing investor documents, an issuer may obtain a letter from a third-party verification provider confirming the investor’s accredited status. The letter must be provided by a certified public accountant, registered broker-dealer, attorney, or registered investment advisor.
There are no specific verification requirements regarding this letter and its appearance. However, these letters usually provide information that includes the test the investor has met, the qualifications of the investor, and the date the review of the letter was conducted.
As you can see, accredited investor verification may be performed directly by the issuer which can involve a significant amount of manual labor, or it may be outsourced to a third-party service provider. The issuer can benefit greatly by choosing the most cost-efficient method to verify the accredited status of their investors.
