- New JOBS Act Rules Regarding Accredited Investor Determination
- November 29, 2016 | Authors: Peter E. Reinert; Steven Strickland
- Law Firm: Lowndes, Drosdick, Doster, Kantor & Reed Professional Association - Orlando Office
- New SEC rules mandated by the JOBS Act require that an issuer’s determination of an investor’s “accredited investor” status must be made as of the last day of the issuer’s most recent fiscal year rather than at the time of the sale of the securities. According to the new rules, the issuer will need to determine whether prior information provides a basis for a “reasonable belief” for a year-end accredited investor determination based on the “particular facts and circumstances surrounding that determination”.
Given that the ability for an issuer to determine accredited investor status on a timely basis is critical for the avoidance of registration requirements, issuers should consider what steps might be appropriate to facilitate the determination of accredited investor status based on the “particular facts and circumstances” involved. Issuers should specifically consider:
- Updating subscription documents to include a negative consent ensuring that investors have an ongoing obligation of verification and that investors must notify the issuer if any change in their accredited investor status occurs; and/or
- Requiring investors to complete an annual accredited investor verification form.
On May 3, 2016, the Securities and Exchange Commission (SEC) adopted final rules regarding the thresholds for registration, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act) mandated by the Jumpstart Our Business Start-ups Act (JOBS Act) and the Fixing America's Surface Transportation Act (FAST Act).
The JOBS Act increased the Exchange Act thresholds for registration by an issuer other than a bank or a bank holding company to total assets exceeding $10 million and a class of non-exempted equity securities held of record by either 500 persons who are not accredited investors or 2,000 persons. In order to rely on the new, higher threshold, issuers must be able to determine which of their record holders qualify as accredited investors. The amended rules use the definition of “accredited investor” set forth in Rule 501(a) under the Securities Act of 1933 (Securities Act), which is part of the Regulation D limited offering exemption, to determine if investors are accredited investors for purposes of the registration provisions of Exchange Act Section 12(g)(1). Under amended Rule 12g-1, the accredited investor determination would be made as of the last day of the fiscal year (as opposed to at the time of sale of the securities). According to the SEC, a company will need to determine whether prior information provides a basis for a reasonable belief for a year-end accredited investor determination based on the particular facts and circumstances surrounding that determination. In adopting a facts-and-circumstances approach, the SEC decided
not to incorporate into the Section 12(g) determination process the more stringent requirement under Securities Act Rule 506(c) that issuers “take reasonable steps to verify” accredited investor status, which applies to issuers using general solicitation to offer securities under that rule.
Factors that an issuer can take into account include such things as information obtained during a securities issuance, third-party certifications, and annual confirmations from investors, although none of these is considered dispositive. The SEC’s statement suggests that an issuer should consider both the nature of the information on which the issuer previously relied in making an accreditation assessment and the age of that information. The SEC expressed particular concern that sole reliance on previously obtained information “could result in the use of outdated and unreliable information” in the status determination. In response to hypothetical circumstances proposed in one comment, however, the SEC acknowledged that, depending on the particular facts and circumstances, information used for accredited investor determinations made in offerings during the three months before the issuer’s fiscal year-end or self-certifications by investors as to their accredited investor status in an offering more than three months but less than twelve months before fiscal year-end could provide a reasonable basis for making an accredited investor determination as of the end of the fiscal year.
The SEC declined the invitation of some commenters on the rule proposal to adopt a safe harbor for establishing a reasonable belief that a security holder is an accredited investor for Section 12(g) purposes. The SEC said it rejected this approach in part out of concern that any such safe harbor “would become a de facto minimum standard.” Noting that SEC rules do not provide a safe harbor for reasonable belief determinations to be made under Rule 501(a) for offerings exempt from Securities Act registration, the SEC concluded that the determinations required for Section 12(g) do not present a more compelling case for having a safe harbor. The SEC expressed the view that the reasonable belief standard under Rule 501(a) provides issuers with both a familiar context and “appropriate flexibility” in making the required determination.