An Overview of the Accredited Investor Verification Process

Accredited investors are investors who have met certain SEC requirements that allow them to invest in less regulated private investment opportunities, such as startups, real estate ventures, private equity, hedge funds, venture capital funds, and more. A prospective investor who wants to invest in these types of opportunities must first go through an accredited investor verification process.

The Accredited Investor Verification Process
An investor can gain accredited status by fulfilling at least one of the SEC’s criteria involving net worth, income, knowledge, or professional affiliation/certifications.

Under Rule 506(c), the issuer must perform “reasonable steps” to verify the investor’s accredited status. Under Rule 506(b), the issuer may rely on the “reasonable belief” standard when determining the investor’s status, which means the issuer may rely on the investor’s word. However, even under Rule 506(b), the issuer should conduct verification by asking investors to fill out a questionnaire that helps verify the status of the investor.

Under Rule 506(c), the methods by which an issuer may conduct accredited investor verification include:

  1. Net Worth Method
    The issuer will request asset/liability documentation to verify whether the prospective investor possesses a net worth of more than $1 million USD (not including the primary residence), either individually or jointly with a spouse or spousal equivalent.
  2. Income Method
    The issuer will request documentation that verifies whether the annual income of the prospective investor has exceeded $200,000 USD individually (or $300,000 USD with a spouse or spousal equivalent) in the previous two years, with the expectation of earning the same or greater in the current year.
  3. Insider Method
    The issuer will need to verify through documentation obtained from the investor that he or she meets the SEC criteria as one of the following:

Executive officer, trustee, director, advisory board member, general partner, or affiliated management person
Knowledgeable employee of a private securities fund
General securities representative, state-registered investment advisor, or private securities offering representative holding a FINRA Series 7, 65, or 82 license in good standing with the relevant member firm

Traditional vs. 3rd Party Verification
The traditional manner of verifying the status of an investor, without help from a third-party accredited investor verification service, can be cumbersome and time-consuming for issuers. Instead of manually verifying the status of each prospective investor, there is a more efficient way.

The issuer may obtain a letter from a third-party verification service that attests to the accredited status of the investor. This may be done as long as the third-party service providing the letter is one of the following: registered investment advisor, registered broker-dealer, certified public accountant, or licensed attorney.

Amended for Rule 506(C) Reasonable Steps
The SEC recently amended Rule 506(c) on the reasonable steps provision for accredited investor verification. This applies to investors who have been initially verified through the reasonable steps provision.

This is a significant help for startups with investors who repeatedly invest in these companies.

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