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Wed Nov. 6th, 2013 PTWWW Legal Alert


Historically, a company seeking to raise capital from investors without conducting a public offering had to comply with rules that prohibited the use of advertising and general solicitation in connection with its capital-raising efforts. 

Effective September 23, 2013, the SEC (Securities and Exchange Commission) issued new Rule 506(c) of Regulation D that allows companies to offer their securities (stock, membership or partnership interests, promissory notes, etc.) using print advertising, billboards, television, the internet, social media, mass mailings and other forms of general solicitation and advertising without registering the offering of those securities as a public offering, but only so long as the company complies with the requirements of newly added Rule 506(c).

The additional requirements in a Rule 506(c) offering are that, while the company can talk with anyone about its securities, the company can only actually sell to purchasers that the company has verified qualify as “accredited investors.”  The new Rule also provides guidelines on the steps a company must take to “verify” accredited investor status.

As a result of new Rule 506(c), a company can choose to use advertising and general solicitation of investors, and then must “verify” the accredited status of the investors.  Or, a company can choose to structure its offering to qualify under Rule 506(b), which mandates that the offering avoid advertising and general solicitation of investors.  In an offering under 506(b) the company can avoid the need to meet the requirement in Rule 506(c) to “verify” the accredited status of the investors. 

Once advertising and general solicitation take place, the company must verify the accredited status of its investors and cannot qualify under another provision of Rule 506.

An accredited investor is defined in Rule 501 under the Act to include:

Individual accredited investors are those with (i) net worth (individually or jointly with the person’s spouse) exceeding $1,000,000, excluding primary residence (the “net worth standard”); or (ii) (a) individual income exceeding $200,000 in each of the two most recent years or (b) joint income with the person’s spouse exceeding $300,000 in each of those years, and in either (ii) (a) or (b) a reasonable expectation of reaching the same income level in the year of investment (the “income standard”).

Common entity accredited investors are (i) entities with total assets of over $5,000,000; and (ii) entities other than irrevocable trusts whose equity owners are all accredited investors, although entities may also be accredited investors under many other standards.

As noted above, to use Rule 506(c), the company must verify accredited investor status.  This means that the company must take “reasonable steps” beyond merely requesting that purchasers check a box in a questionnaire or sign a form to determine whether or not purchasers of the company’s securities are accredited investors.

Each of the following steps is considered “reasonable” as long as the company does not have knowledge that the purchaser is not an accredited investor at the time of purchase:

For a company’s existing individual security holders who purchased their existing securities in a Rule 506(b) offering (i.e., a traditional Rule 506 offering prior to September 23, 2013): obtaining a certification from such purchaser at the time of the new purchase that he or she qualifies as an accredited investor.

For accredited investors under the net worth standard:

  • Reviewing one or more of the following types of documents dated within three months of investment:
  • For assets: bank statements, brokerage statements, and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties;
  • For liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; and
  • Obtaining a written representation from the purchaser that all liabilities necessary to determine net worth have been disclosed.

For accredited investors under the income standard:

  • Reviewing any IRS form that reports the purchaser’s income for the two most recent years (e.g., Form W-2, Form 1099, Schedule K-1 to Form 1065; Form 1040); and
  • Obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the year of investment.

For any accredited investor:  Obtaining written confirmation from one or more of the following persons or entities that such person or entity has taken reasonable steps within the prior three months to verify that the purchaser is an accredited investor:  a registered broker-dealer; an SEC registered investment adviser; an attorney in good standing in all jurisdictions where he or she is admitted to practice law; or a CPA in good standing in the place of his or her residence or principal office.

Where an individual purchaser and his or her spouse are jointly qualifying for accredited investor status, any documents required above are required with respect to both the purchaser and his or her spouse.

Please note that the steps listed above are deemed reasonable, they are not meant to prevent a company using other reasonable means of verifying accredited investor status. 

It should be noted that, on the subject of the payment of finder’s fees to unregistered persons to find purchasers, offerings under Rule 506(c) are subject to the same restrictions as in effect before September 23, 2013, which also remain in effect for offerings under 506(b) or other provisions of Regulation D. 

For more information, please contact David D. Parr or Melisa Perez, partners in our Corporate Practice Group.