If the SEC decides to go back to the drawing board and take a wholly different approach to implementing the lifting of the ban on general solicitation in Rule 506 offerings, one safe harbor (or set of safe harbors) it might well propose could involve third-party services that verify an investor's accredited status.
This is not a new idea.
Annemarie Tierney, General Counsel for the SecondMarket, wrote in a comment letter back in May (here's a post I wrote in June about that letter), soon after the JOBS Act became law and well before the SEC published its proposed implementing rules, that "the verification process could include a requirement that the issuer, or its broker-dealer intermediary, obtain copies of a potential investor's tax returns, W-2, Form 1099 or other income verification documentation for the past two fiscal years, in addition to a pay stub from the current year . . . ."
And in fact the SEC release proposing implementing rules stated that third-party verifiers might well be a method issuers might use to discharge their obligation to take "reasonable steps." Here's language from the release:
"Examples of the types of information that issuers could review or rely upon – any of which might, depending on the circumstances, in and of themselves constitute reasonable steps to verify a purchaser’s accredited investor status – include, without limitation . . . verification of a person’s status as an accredited investor by a third party, such as a broker-dealer, attorney or accountant, provided that the issuer has a reasonable basis to rely on such third-party verification."
The release goes further, in a footnote:
"For example, in the future, services may develop that verify a person’s accredited investor status for purposes of proposed Rule 506(c) and permit issuers to check the accredited investor status of possible investors, particularly for web-based Rule 506 offering portals that include offerings for multiple issuers. This third-party service, as opposed to the issuer itself, could obtain appropriate documentation or otherwise verify accredited investor status. Several commentators, in fact, have recommended that the Commission take action to facilitate the ability of issuers to rely on third parties to perform the necessary verification."
What the SEC release does NOT do, of course, is proposed that issuers be REQUIRED to utilize third-party services to verify the accredited status of investors. Nor does the SEC release propose that use of a third party service constitute a safe harbor, that is, a presumed discharge of an issuer's "reasonable steps" obligation.
I notice that the newest comment letters to the SEC on the general solicitation rules both raise third-party verification. Both letters appear to be from startup companies.
The latest letter (as of this writing) is from a company called Deal Flow Analytics, and it seems to be saying, in effect, take the substance of the footnote about third party verifiers from the release, and turn it into a clear-cut safe harbor. Here's a key passage from that letter:
"[W]e believe [the] process of accredited investor verification should be both mandatory and undertaken by independent third parties with no economic interest in a given securities offering.
"We agree that the pathways to determine accredited investor status should remain flexible, and the steps necessary to determine and verify status in one deal may or may not be necessary and sufficient to determine and verify status in another. It is for this reason that independent, third party service providers, with no deal-related incentives offer issuers the best option in complying with the proposed verification requirements. Such third-party providers will be free of conflicts of interest and more likely to identify fraud or instances of abuse than those engaged in promoting, placing and structuring securities offerings."
Moving next to the next-most-recent comment letter, one from a company called Artivest Holdings, and you get a different take, one that assumes third-party verification services will be just one way the market responds to the "reasonable steps" standard. Implement the rules just as proposed, Artivest advocates. That will create an environment which "may facilitate the utilization of third-party services which can collect information and provide verification as to investor status."
Image: based on photo by svennevenn/Flickr.