Accredited Investor Verification and Why It Matters

Jor Law, Jenny Liang & Gareth Schumacher |

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Pixabay/Gerd Altmann

Many issuers and investors are not familiar with the term “Accredited Investor,” but it’s a concept that is core to capital raising. Previously, capital raises were restricted to private networks of accredited investors. It was hard for companies to find those investors and hard for those investors to find companies. New legislative developments have opened up access to accredited investors through general solicitation in exchange for accredited investor verification. Here’s your chance to learn how accredited investor verification works and how it may work in your favor.

New Rules Improve Access to Capital

Typically, the securities laws enforced by the Securities and Exchange Commission (SEC) requires registration of securities offerings. However, there are certain exemptions to keep in mind. For example, while raising capital, companies may use Rule 506(b) of Regulation D as an exemption, but as part of the rule, they will be prohibited from advertising and generally soliciting for their offering.

A newer exemption, Rule 506(c) of Regulation D, was implemented in 2013 as part of the Jumpstart Our Business Startups Act (also known as the JOBS Act), and it allows for an alternative method of raising capital. This rule permits general solicitation and advertising to anyone so long as eventual sales are made only to accredited investors. Examples of general solicitation include print, TV, radio, and all sorts of internet advertising. Contrast this with the older Rule 506(b) which doesn’t require the newer accredited investor verification process but also doesn’t allow companies to solicit or advertise their private offerings.

According to the new rule, issuers of 506(c) offerings must take “reasonable steps” to verify an investor’s accredited status. Since unregistered investments may pose a higher risk and have a greater chance of loss, this mix of permitted advertising and required verification of accreditation may strike a balance for capital markets. It allows easier access to capital while narrowing the pool to more knowledgeable investors, as well as those who are financially equipped to bear the risk.

What Is an Accredited Investor?

Accredited investor” is defined in Rule 501 (a) of Regulation D. It’s important to note that accredited investors have crucial criteria they must meet, as outlined in this SEC investor bulletin.

The rule reads as follows:

An accredited investor can be one of the following, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

(1) Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

(2) Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;

(3) Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;

(4) Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

(5) Any natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1,000,000.

(i) Except as provided in paragraph (a)(5)(ii) of this section, for purposes of calculating net worth under this paragraph (a)(5):

(A) The person's primary residence shall not be included as an asset;

(B) Indebtedness that is secured by the person's primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and

(C) Indebtedness that is secured by the person's primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability;

(ii) Paragraph (a)(5)(i) of this section will not apply to any calculation of a person's net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:

(A) Such right was held by the person on July 20, 2010;

(B) The person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and

(C) The person held securities of the same issuer, other than such right, on July 20, 2010.

(6) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;

(7) Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in §230.506(b)(2)(ii); and

(8) Any entity in which all of the equity owners are accredited investors.

While the definition can seem unwieldy, for the most part, accredited investors are certain types of financial institutions, companies with more than $5 million in assets or whose equity owners are all accredited investors, or individuals that have high income or high net worth.

How to Get Verified as an Accredited Investor?

There are multiple ways to get verified as an accredited investor. If investors need to get verified through the income method, they should use official tax records such as tax returns, W-2, K-1, 1099, or other government documents, if possible. If that type of official documentation is not available, they may be able to provide evidence through earnings statements, pay stubs, a letter from their employer certifying their income, or perhaps bank statements that show that they received that income.

If investors choose to get verified through the net worth method, they must prove both liabilities and assets, and the positive value of their primary residence may not count toward net worth. The basic math for accredited investor verification is as follows:

i) Add Assets (ignoring the value of the primary residence)

ii) Subtract the amount of debt on primary residence incurred in prior 60 days

iii) Subtract the amount of debt on primary residence exceeding value of primary residence (without duplicating item (ii) above)

iv) Subtract the amount of debt shown on credit report (without duplicating items (ii) and (iii) above)

v) Subtract other liabilities (without duplicating items (ii), (iii) and (iv) above)

For liabilities, if investors have U.S. credit reports, the verifier should review it to confirm liabilities. In addition, investors should be asked for a written disclosure of all other liabilities.

For assets, investors would need to evidence enough assets to demonstrate a net worth of at least $1,000,000 USD, ignoring the value of their primary residence and after discounting all their other liabilities to be excluded per the above definition. These assets could be bank accounts, brokerage accounts, property that is not their primary residence, boats, automobiles, art, or anything that has value. To prove the value of those assets, they would need to provide bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports. All documentation must be no more than 90 days old, with certain exceptions. It’s important for investors to distinguish between assets that they hold versus assets held by companies that they may have some ownership interest in. For example, if investors own real estate property outright under their name, then the real estate property is their asset. If investors hold real estate property through an entity, such as an LLC, then the investors’ asset is not the real estate property but their ownership interest in the LLC instead. In that case, they would need to show a valuation of their ownership interests in the LLC.

For the purposes of verification of trusts or entities on the basis of assets, a trust or entity cannot be formed for the specific purpose of acquiring the securities being offered. Charter documents can sometimes show whether the trust or entity was formed for a particular purpose of acquiring the securities being offered; otherwise, one would generally have to rely on statements of the trust or entity officers to confirm this. With respect to minimum asset requirements, typically, one would evidence this by providing bank statements, audited financials, or perhaps an appraisal of assets held by the trust or entity.

In the case of a trust that needs to evidence that purchase decisions are made by a sophisticated person, a “sophisticated person” is defined as someone (either alone or with his purchaser representative(s)) who has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description. Reviewing a sophistication questionnaire or obtaining an officer’s certificate certifying this might be the most reasonable method of verification.

For trusts or entities that do not meet the minimum assets test, they might also be able to qualify as an accredited investor if all of its equity owners are accredited investors. To evidence that, charter documents or officer’s certificates that represent and warrant as to the complete list of the owners would need to be obtained together with evidence that those equity owners were all accredited investors.

Investors – Get Verified as an Accredited Investor and Watch Out for Unregistered Offering Scams

Getting verified as an accredited investor gives you access to more popular deals, but investors should also pay attention to the potential risks for certain deals. Since unregistered offerings, or private placements, lack the disclosure requirements and some other protections that apply to registered securities, the SEC has issued a warning about potential investment scams. Keep in mind that “no-risk” offers and other aggressive sales tactics serve as strong warning signs. Other red flags may include offerings with no income or net worth requirements, sketchy sales documents, and companies that are not in good standing in the state where they claim to have formed.

Issuers - Stay in Compliance and Verify Your Investors as Accredited Investors

As part of the required “reasonable efforts” on the part of issuers to verify their investors, the SEC specifically allows reasonable reliance on third parties to conduct much-needed verification. Third parties include SEC registered investment advisers, registered broker-dealers, licensed attorneys who are in good standing under the laws of the jurisdictions in which they are admitted to practice law, and certified public accountants who are duly registered and in good standing under the laws of the place of his or her residence or principal office. These third parties have certain registration, licensing, and “good standing” requirements they must follow so they are deemed to be trusted verifiers. Other safe harbor methods include proof of income through tax documents and proof of net worth based on evidence of assets through statements, etc., and evidence of liabilities through a U.S. credit report and written disclosure of liabilities. The verification method can have substantially different risk profiles to the issuers (and their investors) and can also impact the buying process faced by investors. In general, the gold standard is probably to utilize either a single law firm dedicated to doing verification reviews or a third-party service that only contracts with outside attorneys to conduct verification reviews.


Jor Law is a pioneer in building out the ecosystem for digitizing and trading securities on the blockchain and other distributed ledger technologies. A finance and securities attorney, he is most well-known for his expertise in secured lending and alternative finance, including EB-5, venture capital, crowdfunding, and tokenized securities, including initial coin offerings (ICOs) or security token offerings (STOs). He co-founded VerifyInvestor.com which was the dominant accredited investor verification service in the world at the time it was acquired. A trusted consultant/adviser to technology companies primarily in regtech, fintech, and crypto, Jor has advised prominent companies such as tZERO, Polymath, and Prime Trust. Within the crypto space, he's most passionate about securities regulations affecting tokens, identity for regulatory purposes vs privacy and anonymity, and cross-ledger or cross-chain technologies.

Jenny Liang is an operations professional with a legal background in the finance sector. She is serving as the VP of Operations for VerifyInvestor.com, a leading accredited investor verification service provider, a subsidiary company of tZERO. Her prior experience includes operations of an overseas investment company in the EB-5 industry. Her career passion focuses on assisting investors and issuers throughout the investment process.

Gareth Schumacher heads up sales and business development at VerifyInvestor.com. A cryptocurrency and blockchain enthusiast, he studied history at Columbia University and is particularly interested in how technological innovation creates cultural and social change.

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Equities Contributor: Jor Law

Source: Equities News

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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