Thursday, July 05, 2012

State Securities Officials Urge SEC to Require Enhanced Verification of Reg. D Investors in JOBS Act Regulations

In letters to the SEC, securities officials in Ohio and Massachusetts urged the Commission to adopt regulations under the JOBS Act that enhance the verification process for Regulation D accredited investors and avoid a check-the-box approach. William Galvin, Massachusetts Secretary of the Commonwealth,  asked the Commission to establish as a safe harbor or best practice the use of an independent party that would verify the accredited status of potential investors. Ohio Securities Commissioner Andrea Seidt saidn that a check-the-box approach to investor self-verification of accredited status will not suffice because the Title II issuer must have more than a belief that a prospective purchaser is accredited.

Title II of the JOBS Act modifies the exemption provided under Rule 506 of Regulation D to eliminate the prohibition against general solicitation or general advertising provided that all purchasers of the securities are accredited investors. SEC regulations implementing this provision must require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.

The requirement that investors in offerings under the new Rule 506 exemption must be accredited is the sole substantive protection built into the exemption, noted Secretary Galvin. In a Rule 506 offering that is limited to accredited investors, he noted, other protective requirements are waived. For instance, there is no information requirement (no mandated disclosures to investors); no financial statement requirement; no requirement that investors must be sophisticated; and no SEC or state review of either the offering materials or the terms of the offering. Going forward, the Regulation D definition of accredited investor will serve as the sole determinant of whether an investor can invest in unregistered publicly-offered securities transactions.
Because the language of the new Rule 506 exemption calls for verification, reasoned Mr. Galvin, it is clear that Congress intends this responsibility to be a step up from the current requirement that issuers have reasonable belief that investors are accredited. Other language in the JOBS Act also demonstrates that verification is a heightened requirement for issuers, For example,  the Section 201(a)(2) language relating to sales to Qualified Institutional Buyers under Rule 144A requires only "reasonable belief' that a purchaser is a QIB. This contrasting language makes it clear that Congress's use of the term "verify" is purposeful, and the Commission should make the verification requirement robust and meaningful.

While there are some who advocate that the verification process should be as quick and frictionless as possible and regulatory standards should be relaxed, he urged that the verification requirement be construed to actually protect non-accredited investors from risky unregistered offerings

The Secretary said that verification should require issuers to determine whether investors are accredited based on documentary evidence, rather than just representations from potential investors. The statute does not call for investors to simply certify or attest that they are accredited or have a given level of income or net worth. He urged the Commission not to adopt rules that would reduce the requirement to that level since, in his view, permitting issuers to accept mere representations from investors would allow them to rely on unverified assertions.
He also suggested that issuers and other persons carrying out the verification process should be required to designate a key person who will have the responsibility to assure that verification of accredited status is done properly. The key person should be trained to properly verify that potential investors are accredited. If the verification is not done properly, there must be consequences, he emphasized, thus the key person, the issuer, and the platform should be subject to strict sanctions, including fines and potential disqualification from participating in future exempt offerings.

Since many issuers and platforms may not wish, or feel they are not competent, to verify the accredited status of potential investors, he urged the Commission to establish as a safe harbor or best practice the use of an independent party that would verify the accredited status of potential investors. This work could be carried out by qualified broker-dealer firms, banks, or other financial institutions, which have the expertise to carry out this verification and which have procedures in place to protect investors' personal financial information.

The Ohio Securities Commissioner noted that Congress gave issuers greater responsibilities, including a key and active role in taking reasonable steps to verify that each investor is accredited. Title II expressly requires the issuer take multiple, active steps to actually verify accredited status, whereas completing a check-the-box questionnaire entails only a single, passive step taken by the purchaser. As for what multiple, active steps the Commission should require Title II issuers to take, the Ohio Commissioner recommended that issuers review, confirm and maintain appropriate records of the accredited investor’s level of sophistication in a similar fashion to the requirements for sophisticated, non-accredited investors in Rule 506(b)(2)(ii).

The issuer should also review financial statements and/or tax returns evidencing actual satisfaction of accredited investor thresholds; and in the case of accredited investor entities, the issuer should review the accredited investor status of equity owners, and/or review regulatory letters or certificates approving or confirming the entity’s status as a bank, insurance company, registered investment company, business development company, or small business investment company. More broadly, in order to enjoy the benefits of general advertising and general solicitation in an exempt public offering, thereby exposing more of the public to risk, said the Ohio Securities Commissioners, issuers must take a greater and more active role in ensuring that risk is limited to accredited investors who are better able to bear such risk.