Two of the most frequently used exemptions under the Securities Act are Rule 506(b) and Rule 506(c) of Regulation D. What do these rules say in terms of general solicitation? We cover the topics of safe harbor, raising unlimited capital, and reasonable steps below.
Safe Harbor
Rule 506(b) was set up as a nonexclusive safe harbor to achieve adherence with the Securities Act Section 4(a)(2), providing an exemption for an issuer’s transactions that do not involve a public offering. Since the aforementioned section does not provide adequate direction for the conducting of private placements, Rule 506(b) was promoted in order to create a certain pathway for the conducting of private placements according to Section 4(a)(2).
The most frequently used private placement exemption is still Rule 506(b), but Rule 506(c) has increased in popularity since its initial inception in September 2013. If an issuer falls short in complying with every requirement of Rule 506(b), the issuer may utilize another available exemption. Note that once issuers generally solicited their offerings, it is then always a Rule 506(c) offering. There’s no going back to Rule 506(b) and pretending that general solicitation never happened.
Raising Unlimited Capital
Rule 506(b) allows an issuer to raise unlimited capital from an unrestricted number of accredited investors in addition to a maximum of 35 non-accredited investors, but only those who are financially sophisticated. Certain disclosures must be given to non-accredited investors. Under Rule 506(b), no general solicitation and advertising is permitted. Issuers must demonstrate that they had a substantive prior relationship with the investors prior to their knowledge of the investment opportunity.
Lastly, issuers must have a reasonable belief that investors are accredited or financially sophisticated. This is generally established by depending on the answers to investor questionnaires and purchase agreement representations.
Rule 506(c), unlike Rule 506(b), allows an issuer to utilize general solicitation and advertising to raise an unrestricted amount of funds. Of course, as stated before, all purchasers are required to be accredited investors under this Rule. The entire offering may be disqualified if the issuer accepts investment from one non-accredited investor. The issuer has no other exemption available except the more complicated Regulation A+ if failing to adhere to the Rule 506(c) provisions.
Reasonable Steps
Rule 506(c) requires the issuer to take reasonable steps to verify that the investors obtained through general solicitation are accredited.
Rule 506(c) includes acceptable verification methods that may be used. Issuers may verify the income of an investor by reviewing items such as W-2s, tax returns, and form 1099s. They may verify net worth by reviewing bank statements, credit reports, and brokerage statements. Issuers may also recognize any recently written confirmation provided by an SEC-registered investment advisor, a licensed attorney in good standing, licensed certified public accountant in good standing, or registered broker-dealer.
The above has provided some overview on the differences between how general solicitation is handled under Rule 506(b) vs. 506(c).
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