Before 2013, issuers were prohibited from using any means of general solicitation or advertising when raising capital in the private markets. The prohibition was perceived by many to be the single biggest impediment to raising capital privately, particularly since it foreclosed the use of perhaps the greatest capital raising tool ever created: the Internet.
That all changed in 2013 when the Securities and Exchange Commission created new Rule 506(c) under the JOBS Act of 2012, which allowed companies for the first time ever to seek investors through general solicitation and advertising without registering with the SEC, so long as they sold only to accredited investors and used reasonable methods to verify accredited investor status.
So what are reasonable methods of verification? It clearly involves something more than what would meet the “reasonable belief” standard for determining accredited investor status for purposes of the 35 non-accredited investor cap for Rule 506(b) offerings, which as a practical matter means self-attestation through an investor questionnaire. That would not fly under Rule 506(c)’s reasonable verification method standard.
Rule 506(c) contains a non-exclusive list of techniques that would serve as safe harbor reasonable verification methods, including inspection of bank statements, tax returns and brokerage statements, as well as third-party attestation. The adopting release stated that reasonableness is an objective standard based on facts and circumstances; by way of example, a high minimum investment amount would require less verification than a low minimum, or no additional verification at all.
But the use of Rule 506(c) crowdfunding has nevertheless been disappointingly low, largely because of the lingering perception that the enhanced verification requirement creates inefficiencies in the offering process and is invasive to investors.
Last month, the SEC Staff provided further guidance in the form of a No-Action Letter and two new Compliance and Disclosure Interpretations as to the specific circumstances under which a high minimum investment requirement would satisfy the reasonable verification requirement under Rule 506(c).
2013 Adopting Release on Minimum Investment Amounts
In stressing that “reasonableness” was an objective standard based on facts and circumstances, the 2013 adopting release for Rule 506(c) stated that the “more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify accredited investor status, and vice versa.” It then cited minimum investment amount as an example:
“if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party.”
In other words, a high minimum investment amount contributed or committed to by an investor in an offering could mean that the issuer need not have to implement any other verification methods such as inspecting brokerage statements or obtaining third party attestations.
March 2025 No-Action Letter
In March 2025, the Staff of the Division of Corporation Finance of the SEC received a letter requesting interpretive guidance as to a specific application of the SEC’s determination (in its 2013 adopting release) regarding use of a minimum investment amount as an appropriate factor in completing the required verification steps in Rule 506(c) offerings.
The request letter described a fact pattern in which an issuer requires minimum investment amounts of at least $200,000 for natural persons and $1,000,000 for legal entities, and also obtains written representations from the investor confirming (i) accredited investor status and (ii) that the minimum investment amount was not financed by a third party for the specific purpose of making the investment. Finally, the issuer would have no actual knowledge that any investor is not accredited or that any minimum investment amount was financed for the specific purpose of making the particular investment in the issuer.
The request letter further stated that, as to any legal entity purchaser claiming accredited investor status solely from the accredited investor status of all of its equity owners, the issuer would also obtain in writing from the purchaser representations that (i) all of its equity owners are accredited investors, (ii) each of the purchaser’s equity owners has a minimum investment obligation to the purchaser of at least $200,000 for natural persons and $1,000,000 for legal entities; and (iii) the minimum investment amount of each of the purchaser’s equity owners is not financed by any third party.
In its No-Action Letter of March 12, 2025, the Staff agreed that, based on the representations in the request letter, the issuer could reasonably conclude that it has taken reasonable steps to verify that investors in the Rule 506(c) offering are accredited investors, namely (i) minimum investment of $200,000 for individuals and $1,000,000 for legal entities, (ii) investor representations as to accredited investor status and no use of third party financing for the investment, and (iii) no actual knowledge on the part of the issuer that the investor is either not accredited or has used third party financing to make the investment.
On the same day, the Division of Corporation Finance also issued two Compliance and Disclosure Interpretations confirming that if an investor satisfies a minimum investment requirement, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status under Rule 506(c), other than to confirm that the purchaser’s cash investment is not being financed by a third party, and assuming the absence of any facts that indicate that the purchaser is in fact not an accredited investor.
Potential Impact
So what is the likely impact of the no-action letter guidance? Tough to tell.
First of all, no-action letters merely reflect the views of the Staff, and do not have the force of a rule or regulation. Also, the guidance from a no-action letter is limited to the particular facts and conditions laid out in the related request letter. But no-action letters are nevertheless very influential and are broadly followed by practitioners.
As to the substance of the guidance: On its face, one would expect an increase in Rule 506(c) offerings as a result of the Staff’s endorsement of specific circumstances for using a minimum investment amount as an appropriate factor in satisfying the required verification steps in Rule 506(c) offerings. Moreover, the relatively high minimums included in the No-Action Letter ($200,000 for individuals and $1,000,000 for entities) would suggest this would benefit issuers conducting offerings at the higher end of the range. Those issuers would more likely be private investment fund sponsors and perhaps late stage startups.
But private investment fund sponsors almost always solicit within their own networks and don’t have the need (or desire) to go outside of their network and conduct general solicitations to find investors. Similarly, investors that invest in private investment funds do so as a result of direct solicitations rather than online ads or other methods of general solicitation. Later stage startups also tend to solicit those in their own networks, first and foremost from among their existing investors. So the existence of and reliance on established networks by those who would otherwise seemingly benefit from the newly endorsed verification pathway might mean that the impact might be muted.
The great promise of Rule 506(c) was that it would democratize investment. Rule 506(c) was supposed to level the playing field for those issuers not located in the large innovation ecosystems (Silicon Valley, New York City, Boston, Austin, Seattle) or for emerging founders and investment fund sponsors who had not yet had the opportunity to develop extensive networks from which to solicit investment.
The relatively high minimum amounts included in the No-Action Letter guidance will be of little practical value to emerging founders and fund managers, and those experienced founders and fund managers with track records and extensive networks have far less need for using general solicitation methods to find investors. For these reasons, I believe the new guidance may not have the kind of significant impact that many are hoping for.