Cannabis CEOs, Make Sure you are SEC Compliant! Part 2: Accredited Investors
As mentioned in the previous article, there are many regulations cannabis companies should consider as they begin raising funds.
Generally, any offer to sell securities must be registered with the Securities and Exchange Commission (SEC) unless it qualifies for an exemption. The two most common exemptions used are found at SEC Regulation D: Rule 506(b) and Rule 506(c).
When companies choose the Rule 506 exemption they don’t need to register their securities offering with the SEC, but must file a Form D (that includes certain information about the company’s promoters, executive officers and directors, and details about the offering) with the SEC after they first sell their securities.
Because the purpose of SEC oversight is investor protection, the SEC exempts these companies from many SEC filing regulations because these offerings are made to accredited or sophisticated investors. These investors possess “financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves to render the protections of the Securities Act’s registration process unnecessary” (SEC Rule 501). Rule 501 classifies investors into three categories: accredited, sophisticated, and unaccredited.
ACCREDITED INVESTORS: The SEC defines an accredited investor as a natural person with (1) a net worth or joint net worth with the person’s spouse exceeding $1 million, not including the value of the primary residence, and / or (2) annual income of $200,000 in each of the two most recent years, or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income in the current year.
The following are also considered accredited investors:
- A bank, insurance company, registered investment company, business development company, or small business investment company;
- An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- A charitable organization, corporation, or partnership with assets exceeding $5 million;
- A director, executive officer, or general partner of the company selling the securities;
- A business in which all the equity owners are accredited investors;
- A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
SOPHISTICATED INVESTORS: This investor does not meet the qualifications of an accredited investor, but is deemed to have sufficient investment or business experience to evaluate an offering.
UNACCREDITED INVESTORS: This category encompasses everyone who is neither an accredited investor nor a sophisticated investor.
Rule 506(b) allows companies to raise unlimited amounts of money, but it prohibits general solicitation, which means that the specific investment opportunities may not be advertised to the general public. Rule 506(b) allows companies to have an unlimited number of accredited investors and up to 35 other non-accredited, sophisticated investors. In addition, the SEC recommends that companies operating under 506(b) have or establish a pre-existing relationship with investors.
On the other hand, companies that operate under 506(c) (Title II of the JOBS Act), can generally solicit accredited investors and publicly advertise specific investment opportunities (this opens opportunities to advertise on social media and other sites), but the investor accreditation status must be reasonably verified by collecting information such as tax returns or a verification letter from an accountant or investment advisor.
I know it’s a lot to digest, but we are committed to providing you with the most relevant information we can. Feel free to contact me directly if you’re interested in compliance issues!