In a March 12, 2025 no-action letter, the SEC staff provided commonsense guidance relating to verification of accredited investor status under rule 506(c).[1] The guidance aligns with industry practice and has the potential to unlock value for both fund sponsors and individual investors, while also creating more certainty in the market.
The exemption under Rule 506(c) permits general solicitation of the public but requires that the "issuer take reasonable steps to verify that purchasers of securities […] are accredited investors."
The SEC staff letter acknowledges certain industry practices that are a regular part of private fund subscription processes, i.e., minimum investment thresholds and detailed representations and warranties with respect to investor assets and fitness, are sufficient to satisfy the aforementioned "reasonable steps" condition stipulated under Rule 506(c). By aligning the exemption's requirements with industry practice, the SEC staff has created a potential for increased industry efficiencies, as existing processes can be used for funds to benefit from the 506(c) exemption. Additionally, both fund sponsors and investors can potentially benefit from increased marketing and information which may facilitate investment in assets that garner outsized or uncorrelated returns.
Despite the enumerated potential benefits, sponsors should still take a selective approach when taking advantage of the exemption, as investment advisors registered under the Investment Advisers Act of 1940 are still subject to strict marketing rules with respect to subject matter that can be used in marketing material.
Existing Practice and the Letter
Private funds operating under Rule 3(c)(1) or 3(c)(7) exemptions usually implement minimum investment thresholds as a matter of regulatory, strategic, and/or operational imperatives.
In addition, subscription documents for private funds generally include representations and warranties on behalf of the investor as to items like sophistication, investor relationship, and net worth to prove a preexisting substantive relationship, but also contain specific provisions that are derivative of the definition of accredited investor and effectively cause the investor to represent as to their accredited investor status. Appendices to the main subscription agreement will usually include forms that require the investor to affirm to the applicable accredited investor criteria that best fit their profile (reinforced by another representation that the affirmation is being provided faithfully).
The SEC staff letter is an acknowledgment of well-designed and ubiquitous industry practice and an indication that current practices of private funds are sufficiently robust to meet the requirements of the 506(c) exemption.
An Efficient Outcome
New funds and existing private funds seeking to utilize the 506(c) exemption following the issuance of the letter will benefit from a large knowledge base and documentation infrastructure that fund formation lawyers are well versed in. The time spent and effort exerted in developing appropriate processes to meet the requirements of the exemption for new funds seeking to benefit from the exemption will be reduced significantly, as current private funds practices can be used as a basis for subscription documentation related to funds intending to operate under the 506(c) exemption. Private funds seeking to expand their investor base through general solicitation will be able to utilize existing documentation with minimal revision. However, funds must still take care to document investor qualifications in order to mitigate enforcement exposure.
Unlocked Value for Investors and Benefits to New and Emerging Managers
Until the letter's guidance, there was little or no public presence for private funds, and so most accredited investors have been unable to access these potentially rewarding assets directly. Most accredited investors will contract with an advisor to make investments in private funds with which the advisor has a preexisting relationship (with payment of significant fees for such services). The SEC staff letter facilitates the potential for more public presence of private funds by minimizing the amount of cost, effort, and risk associated with general solicitation and enabling funds to benefit from potentially exceptionally rewarding assets without paying additional fees for advisory services to access said investments.
On the other side of the coin, private funds benefit from new investor bases and a larger pool of capital. Investor diversification can also be of great importance to new and emerging fund managers that are more subject to investor scrutiny during their initial operational stages as they develop a track record. Accredited investors are also not as asset rich as qualified purchasers. Thus there is an increased risk of accredited investors defaulting on capital calls. Increasing and diversifying the investor base helps to mitigate these risks for new and emerging managers that are focused primarily on accredited investors.
Prudent Approach
As advisers look to take advantage of this new guidance by more widely marketing their funds or investments, it important to remember that Rule 206(4)-1 under the Investment Advisers Act of 1940 (the "Marketing Rule") will continue to apply to their activities. If, for example, promotional materials include descriptions of a fund's performance, the Marketing Rule provides that gross performance may not be presented without also showing net performance, though recent SEC guidance will assist advisers in complying with this requirement.[2] If any third-party testimonials or endorsements for which (other than de minimis) compensation is paid are to be used in soliciting clients, the parties must enter into a written agreement detailing the scope and payment terms of such activities and that agreement itself will need to be disclosed. Advisers are required to disclose any sort of "material conflicts" on the part of the person making the testimonial or endorsement—in other words, advisers must be clear about why the person promoting the fund is choosing to do so. Finally, and perhaps most importantly, advisers cannot also look the other way if a third-party promoter is using fraudulent or misleading materials to solicit clients—the Marketing Rule also requires advisers to have "a reasonable basis" to believe that the testimonials/endorsements comply with requirements of the Marketing Rule.
[1] https://www.ecfr.gov/current/title-17/chapter-II/part-230#230.506
[2] On March 19, 2025, the SEC Staff published two FAQs that clarified that this requirement will not apply to individual investments so long as the fund level information (associated with that investment) is presented in a manner consistent with the Marketing Rule.