Why box-checking isn’t enough
In the Latham Letter blog, we briefly touched on the concept of “checking the box” in Reg D. I know that many issuers (and sometimes their counsel) believe that to prove that an investor is accredited, all you need to do is have them sign an accredited investor questionnaire, checking a box describing what type of accredited investor they are (income, net worth, investments in excess of $5 million, etc.). This raises two, fairly nuanced, issues: (1) is checking the box enough to establish a “reasonable basis” for 506 offerings and (2) is checking the box enough to show that you had no general solicitation in your 506(b) offering?
Reasonable Basis. This is somewhat confusing, so hang with me. You know that the accredited-investor status of your investors matters for both types of 506 offerings. And you also know that, for 506(c), you have to take “reasonable steps to verify” that all of your investors are accredited. But, and this may be news to some, within the definition of “accredited investor” itself (i.e., you won’t find this in 506(c)) is yet another requirement: issuers have to “reasonably believe” that the investor meets one of the accredited investor qualifications. So how do you establish reasonable belief? I hate to do this, but I am giving you the Lawyer Answer: it depends on the situation (very annoying, I know). You’ll need to talk to someone, like me, who knows this area. It isn’t rocket science, but it is situation-specific.
No General Solicitation. 506(b) does not allow general solicitation; it does not permit advertising. One way to show that you’ve not done any advertising is to make sales only to investors with whom you have a “pre-existing, substantive” relationship before you started the offering. How do you show this?
Most issuers have investors sign an accredited investor questionnaire, where the investor checks a box next to the type of accredited investor they claim to be. But merely checking the box is not enough to establish a substantive relationship for 506(b); you must go a step further. You have to have some other information about that person. And what that additional information is, as with establishing a “reasonable belief,” depends on the situation.
This isn’t just me saying that. Here’s how CorpFin puts it: “self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a ‘substantive’ relationship.’” (See CDI No. 256.31.)
I totally get that the market is comfortable with check-the-box. But if you are using it to show no general solicitation, know that SEC staff isn’t. Using it for that purpose opens issuers up to Section 5 liability and investor rescission.
