Regulation D, Rule 506(c), Elimination of Prohibition Against General Solicitation
Title II of the JOBS Act created a new exemption for Rule 506 offerings to allow an issuer to engage in general solicitation and advertising, so long as all purchasers of the securities are accredited investors. The goal of this new exemption is to make it easier for early stage and small companies to raise capital by allowing them to solicit investments from a larger pool of investors. In July 2013, the SEC adopted final rules adding the new Rule 506(c), so this exemption is currently available. The elimination of the prohibition against general solicitation is expected to enable issuers to solicit potential investors directly, through both physical (e.g., mailings, newspaper advertisements, and billboards) and electronic (e.g., the Internet, social media, email, and television) means, increasing their access to sources of capital. The SEC estimates that at least 8.7 million U.S. households, or 7.4% of all U.S. households, qualified as accredited investors in 2010, based on the net worth standard.
In Rule 506(c) offerings, issuers can widely solicit and advertise for potential investors without any limitation on the offering amount, but they are required to take reasonable steps to verify the accredited investor status of the purchasers. In other words, there is no restriction on who an issuer can solicit, but an issuer faces restrictions on who is permitted to purchase its securities. Whether the steps taken are reasonable would be an objective determination by the issuer in the context of the particular facts and circumstances of each purchaser and transaction. Issuers should consider a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor, such as: (i) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (ii) the amount and type of information that the issuer has about the purchaser; and (iii) the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
The issuer would be deemed to take reasonable steps if it uses one of the non-exclusive and non-mandatory methods provided by the SEC to verify the purchaser’s accredited investor status, except where the issuer has actual knowledge that the purchaser is not an accredited investor. For example:
- Income: Tax forms for the two most recent years, along with a written representation from the purchaser regarding income during the current year;
- Net worth: Recent bank, brokerage, or other similar statements showing assets; a consumer report from a nationwide consumer reporting agency showing liabilities; or a written confirmation from a registered broker-dealer, investment advisor, licensed attorney in good standing, or CPA; or
- Prior dealing: If the potential purchaser has purchased securities in an issuer’s Rule 506(b) offering as an accredited investor and continues to hold such securities, a certification from the purchaser that he or she qualifies as an accredited investor at the time of sale.
There can, of course, be situations where a person could provide false information or documentation to an issuer in order to purchase securities in a Rule 506(c), circumventing whatever reasonable steps the issuer has taken to verify that a purchaser is an accredited investor. In such case, the SEC’s view is that the issuer will not lose the ability to rely on Rule 506(c) for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor at the time of sale.
Overall, the relative simplicity regarding the regulatory and financial requirements would make Rule 506(c) offerings an attractive option for early stage and small businesses, perhaps much more so than the much-heralded Title III crowdfunding exemption, which would impose significant and ongoing regulatory and financial burdens on issuers and intermediaries alike. For these reasons, some commentators go so far as to claim that Rule 506(c) is likely to be the “real” crowdfunding exemption, as well as the dominant exemption for most other unregistered offerings.
In our next post, we will discuss exempt offerings under Regulation A.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
About the Author
So-Eun Lee – So-Eun Lee is an associate attorney in the New York office of The R. Shawn McBride Law Office, P.L.L.C. She concentrates her practice on business law. So-Eun can be contacted at: (347) 921-0173 or email@example.com. Her profile is available on www.mcbrideattorneys.com.
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: (214) 418-0258; firstname.lastname@example.org, or www.mcbrideattorneys.com.
 See Jumpstart Our Business Startups Act § 201(a)(1).
 See generally 78 Fed. Reg. 44,771 (July 24, 2013).
 Id. at 44,796.
 Id. at 44,793.
 SEC, Fact Sheet: Eliminating the Prohibition on General Solicitation and General Advertising in Certain Offerings (July 10, 2013), http://www.sec.gov/news/press/2013/2013-124-item1.htm (last visited Apr. 7, 2015).
 78 Fed. Reg. at 44,776.
 17 C.F.R. § 230.506(c)(2).
 78 Fed. Reg. at 44,783.
 Robins, supra n.2, at 5.