By Laura Anthony, Esq.
Application of the Increased Threshold for Accredited Investors
Knowing whether an investor or shareholder is accredited has always been a basic premise in determining the availability of an exemption from the registration requirements and the disclosure delivery requirements applicable to such an exemption. The new registration and deregistration thresholds now extend the importance and timing of knowing the accredited status of shareholders beyond what was ever previously required.
Identifying accredited investors for purposes of the registration, and especially deregistration, requirements could be problematic. Suggestions in this regard included: (i) allowing issuers to rely on annual affirmations from record shareholders; (ii) reliance on information obtained at the time of an initial investment or most recent sale of securities to such investor; or (iii) third-party verification.
The new rules rely on the current definition of “accredited investor” enumerated in Securities Act Rule 501(a) and require that the “accredited investor” determination be made as of the last day of the fiscal year rather than at the time of the sale of securities. This provides a dramatic change for issuers who currently have no obligations to assess accredited status after a sale of securities is completed.
In rejecting the ability to unilaterally rely on representations made at the time of a sale of securities to a particular investor, the SEC expressed concern regarding the use of outdated, unreliable information. Instead, an issuer will need to determine, based on facts and circumstances, whether it can rely upon prior information to form a reasonable basis for believing that the security holder continues to be an accredited investor as of the last day of the fiscal year.
The new rule requires the company to have a reasonable belief as to whether a shareholder is accredited. The SEC is leaving it to the discretion of the company to determine, based on facts and circumstances, whether it has a reasonable belief that a shareholder is accredited or not. A company is not precluded from relying on prior information if it has a reasonable belief that such information is still accurate, such as based on the close proximity to the time of sale. The SEC notes that sale information can be years or even decades old, in which case the issuer could not, of course, rely on such prior information.
However, this begs the practicality question of how exactly that issue will gain the information. The SEC declined to offer guidance, establish a safe harbor, or otherwise provide any assistance to companies in this regard.
It seems to me that issuers will now need to obtain contractual agreements from investors to provide updated representations; however, determining fair and reasonable consequences for a breach of such an agreement is problematic. Direct damages will be hard to determine. I doubt an issuer could claim that the shareholders’ refusal to provide updated information results in the issuer having to register, or continue reporting, and seek damages in the amount of reporting costs. Likewise, investors will balk at consequences directed toward their share ownership, such as a restriction on voting or dividend rights, though remedies along these lines seem the most workable.
As the proliferation of rules centered on a distinction between accredited and non-accredited investors continues, the definition of accreditation has become the subject of much debate and the SEC is considering, and ultimately will implement, changes to the definition. For further reading on the definition of accredited investor, see my blog HERE.
Note 1: Read Part I of this Article. Click HERE
Note 2: Read Part II of this Article. Click HERE
Note 3: Original appeared on Legal & Compliance, LLC on 10 May 2016. Click HERE
Securities attorney Laura Anthony is the founding partner of Legal & Compliance, LLC, a corporate, securities and business transactions law firm. The firm’s experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances.