As part of the crowdfunding regulations, the SEC created heightened standards for determining whether an investor was accredited, requiring issuers (that means the startup company) to take “reasonable steps” to determine whether each investor who is part of a general solicitation offering under 506(c) is in fact accredited.
Here’s a short overview of these rules, prepared in part by Angelina Bruno-Metzger:
- The company must only allow accredited investors into the round.
- The company must take reasonable steps to verify that all investors are accredited.
- The company must declare in a filing with the SEC that a publicly advertised offering was conducted.
Here’s part of the main text:
Meets SEC standards for both privately and publicly fundraising companies.
And here’s the related statement from their FAQ:
Does an Accreditation Report constitute “reasonable steps to verify” accredited status?We have worked very hard to match the evidence we collect to the standards contained in the SEC’s regulations, but we do not make any guarantees.Ask your lawyer.
So, what should you do?
506(c) is vague on what “reasonable steps” means, but that’s supposed to give you flexibility. The core issue is that self-verification is no longer sufficient. The next logical step seems to be some objective evidence, or a good proxy for objective evidence. If you don’t see the documents yourself, you have to rely on someone else to have seen them.
This model is what AngelList has implemented; here’s the part you’re supposed to rely on in an investor’s accreditation report:
A letter from our attorney, or your designated third party advisor, stating that you have presented documents that indicate either income or assets above the required SEC accreditation threshold.
This means that the investor can include a letter from a lawyer or accountant as stated, or that AngelList will have their lawyer look at the documents and make the same statement.
Does that work? Well, it’s certainly close. Here’s what the SEC says does work:
a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the last three months and has determined that such purchaser is an accredited investor
What’s missing from the AngelList letter (sample report) is a definitive declarative statement. The party giving the letter doesn’t say that reasonable steps have been taken, stating judgment was exercised: the sample letters says only that documents were seen, leaving you to make the [desired] inference that the steps were reasonable. The letter doesn’t even address the issue of reliance.
You’re right — so what? If the SEC later determines that you didn’t take reasonable steps with an investor, the implication is that the entire offering exemption is lost. No one knows for sure, and everyone other than the SEC will argue that the loss of exemption should apply only to the specific investor, who in turn should be the only one with a recission right.
If the whole exemption is lost, companies will eventually require AngelList or other third-party verification services to be more explicit in their confirmations. There’s not much harm to the verification companies in doing so, since they’re not liable for mistakes, especially where the issuer hasn’t contracted for any liability. Good faith mistakes will keep most away from negligence liability.
Look back at the exemption requirements: not only do all the purchasers have to be accredited investors but the reasonable steps have to have been taken to verify for each purchaser. I read this as a clear signal by the SEC that there will be no “no harm, no foul” defense here.
Given that the requirement isn’t onerous in the first place, in this third-party model, making the letter more robust seems like a wise modification to keep everyone headed in the right direction.