The 506(c) Verification Gap That Can Undo a Capital Raise

Most of the verification mistakes I see in private offerings aren't dramatic. Nobody forges a tax return. The deal closes, the money moves, everyone signs the accreditation box on the subscription agreement. The problem shows up later, quietly, in a document request from a regulator or a plaintiff's attorney — and by then it's a paperwork problem wearing a compliance costume.

The root of it is a distinction a lot of sponsors never fully internalize: under Rule 506(c), taking an investor's word that they're accredited is not enough. You have to take reasonable steps to verify it. And the moment you advertise your raise, that's the standard you're held to.

Two exemptions, two different standards

Regulation D gives most private issuers two roads.

Under Rule 506(b) — the traditional private placement, no general solicitation — you can generally rely on an investor's own representation that they're accredited, as long as you don't have reason to doubt it. A questionnaire and a signature carry real weight here.

Under Rule 506(c) — the version that lets you publicly advertise and generally solicit — the trade-off for that freedom is a higher bar. The rule is explicit: "The issuer shall take reasonable steps to verify that purchasers of securities sold in any offering under paragraph (c) of this section are accredited investors." Self-certification alone does not satisfy it.

That single sentence is where a surprising number of raises quietly drift offside. A sponsor runs a 506(c) offering — posts about it on LinkedIn, emails a broad list, mentions it on a podcast — but verifies investors the 506(b) way, with a signed questionnaire and nothing behind it. The offering is public; the verification isn't keeping up.

What "reasonable steps" actually asks for

The standard is principles-based — facts and circumstances — but the SEC also wrote a non-exclusive safe harbor into the rule: a short list of methods that, if you follow them, are deemed to satisfy the requirement. You don't have to use them, but they're the clearest map of what "enough" looks like. These enumerated methods are written for verifying individual, natural-person investors; entity and trust investors are handled under the general reasonable-steps standard, which is its own analysis.

• Income. Review the investor's IRS forms reporting income for the two most recent years, plus a written representation that they reasonably expect to hit the qualifying income level again in the current year.
• Net worth. Review specific asset documentation dated within the prior three months — bank and brokerage statements, certificates of deposit, tax assessments, and independent appraisal reports — and, for the liabilities side, a consumer report from a nationwide credit reporting agency, plus a written representation that all liabilities have been disclosed.
• Third-party confirmation. Obtain a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney in good standing, or a certified public accountant, stating that they've taken reasonable steps to verify the investor within the prior three months.
• Prior investor (narrow). The rule includes a fourth method, but it is narrow and rarely fits a new raise: it covers someone who bought into this same issuer's earlier Rule 506(b) offering as an accredited investor before September 23, 2013 and still holds those securities. It is not a general "we verified them last year, so we're covered" allowance; reusing an older verification otherwise is a facts-and-circumstances judgment for your counsel.

Two details in there do a lot of quiet work. The net-worth documents have to be recent — within the prior three months — and the third-party letter carries the same freshness window. Verification isn't a one-time, forever event; it has a shelf life.

Where sponsors actually get tripped up

In practice, the gaps cluster in a handful of predictable places.

The questionnaire-as-verification trap.

A signed accreditation questionnaire is an investor's representation. Under 506(c) it's a starting point, not the finish line. It documents what the investor says, not the steps you took to verify.

Timing against the close.

A verification letter or document set obtained early in a long raise can age out of that three-month window before the deal actually closes. On a raise that runs six or nine months, verification has to be scheduled backward from the close date, not the soft-circle. Tracking which of thirty or fifty investors were verified when, and re-checking the ones going stale before you close, is its own small operations problem — and a big part of why sponsors stop doing this in a spreadsheet.

Entity and trust investors.

In a lot of asset classes — real estate especially — entity investors aren't the exception, they're the norm: self-directed IRAs, revocable living trusts, single-member LLCs, one-off SPVs. Each one is its own accreditation question (an entity can qualify on a $5 million total assets test, among other paths, and some require looking through to the underlying owners). Waving an entity through on the strength of an individual's questionnaire is a common miss.

The liabilities half of net worth.

Net worth is assets minus liabilities. Plenty of files document the assets and take the investor's word on the debts. The safe harbor asks for a consumer report precisely because the liabilities side needs its own evidence.

Thin documentation of the steps themselves.

The rule is about the steps you took. If your file can't show what you reviewed and when, you didn't really take them, no matter how diligent you actually were.

What a defensible file looks like

None of this is exotic. A clean 506(c) verification file tends to share a few features:

• One verification method chosen and documented per investor, matched to how that investor actually qualifies.
• For the net-worth route, evidence of asset value plus a consumer report for liabilities — and for real estate, a recent basis for value (a current tax assessment often does the job; a full appraisal isn't always required).
• Timing tied to the close, so nothing has aged past three months when the money comes in.
• Entities and trusts handled as their own analysis rather than folded into an individual's paperwork.
• A single place where the record of what you reviewed and when lives, so the file speaks for itself later.

Many sponsors reach for the third-party confirmation route specifically because it keeps the investor's tax returns and account statements out of the sponsor's own hands — a licensed professional does the review and issues a letter. Others handle it in-house. Either can satisfy the rule; the point is that something did the verifying, and you can show it.

Why this protects the investor, too

It's easy to read all of this as a compliance chore, but there's a second effect worth naming. An investor deciding whether to trust a sponsor is reading signals — how organized the data room is, how the questions get answered, whether the operation feels rigorous. A sponsor who runs a real verification process is sending exactly that signal. The same discipline that protects the exemption also tells a limited partner they're dealing with an operator who does the unglamorous things correctly. Trust, in private markets, tends to be built out of small, boring competencies like this one.

The takeaway

If you're running a 506(c) raise: confirm you're actually meeting the verify standard, not the 506(b) rely-on-their-word standard; time your verifications to the close; treat entity investors as their own question; and keep a file that shows the steps you took. None of it is hard. The sponsors who find it painless are the ones who worked backward from the close before the raise opened, rather than after.

This article is a description of how the rule works in practice, not legal advice, and I'm not an attorney. Every claim about Rule 506(c) above tracks the text of 17 CFR 230.506(c); the specifics of your offering belong with your securities counsel.

Ross Hancock is the founder of AccreditedNow, which provides CPA-signed accredited-investor verification letters for Reg D 506(c) offerings. He is not an attorney or a CPA, and this article is educational, not legal advice.