Regulation D (506(c)) – General Solicitation
Title II of the JOBS Act (“Title II”) removed the ban on general solicitation of Regulation D 506 offerings, subject to the adoption of rules by the Securities and Exchange Commission. The SEC recently offered proposed rules (the “Rules”) on July 10, 2013. This post is an overview of the Rules.
In order to qualify as a 506(c) offering (and thus be able to generally solicit):
- Rules 501, 502(a), and 502(d) must be followed;
- All purchasers must be accredited investors (This is misleading. In fact, if reasonable steps to verify are taken, and if the issuer has a reasonable belief that the investor is accredited, then that is enough. See the last full paragraph on page 43 of the Rules), and
- The issuer must take reasonable steps to verify that the purchasers are accredited investors
What are “reasonable steps to verify” accredited investor status? The SEC gives a principal-based approach and non-exclusive verification methods which, if taken, would be considered reasonable.
Principal-based approach – in a principal-based verification, issuers would consider a number of factors to determine whether the steps they took to verify were reasonable, including but not limited to the following:
- Nature of the purchaser and the type of accredited investor that the purchaser claims to be – if the purchaser is claiming accredited investor status by virtue of the fact that he is a broker-dealer, then the reasonable steps might only include verifying with FINRA that he is, in fact, a broker-dealer;
- Amount and type of information that the issuer has about the purchaser – if the purchaser is a CEO of a public company, for instance, you can verify her salary through public documents, so the process for verification might be negligible. (If an issuer already knows that an investor is accredited, the issuer does not have to take any steps at all – FN 111). Or if a third party can verify the accredited nature of the person; and
- Nature of the offering – Issuers soliciting through the internet to anyone would mean that additional steps might be necessary. Also, if the investment amount is high ($100,000 or over), then there is less concern about that person being an accredited investor, by virtue of the fact that unaccredited investors are less likely to invest such high amounts.
Non-Exclusive Verification Methods – these are examples of accredited investor verification steps for natural persons which would be considered reasonable:
- Income-Based Verification – Copies of any IRS document that shows income (W-2, K-1, 1099, 1040, etc) for the two most recent years, along with written verification that investor will reach accredited limits in the current year.
- Net Worth-Based Verification – A copy, within the past three (3) months, of the following:
- bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties;
- a credit report from at least one of the nationwide consumer reporting agencies is required; and
- a written statement that all liabilities necessary to make a determination of net worth have been disclosed.
- Third-Party Verification – written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor. Other persons could potentially serve as third party verifiers, subject to additional rules.
- Roll-Over Accrediteds – Those people who were treated as accredited investors under a prior 506(b) offering by the same issuer are deemed to be accredited investors in future 506(c) offerings, provided that such investor certifies that he is an accredited investor.
Other Key Items to Note:
- 506(c) offerings are deemed to be “covered” securities, meaning that they are not subject to state Blue Sky laws.
- The integration rules in 502(a) apply to 506(c) offerings, meaning that if you plan to have two separate raises within 6 months, then the two are considered one offering unless you pass a five-factor test.
- The Form D for a 506(c) offering must be filed in advance of the sale of any security. There is a “check the box” item on the Form D for those choosing to offer 506(c) securities.
- You can choose not to generally solicit. If you do, then the same rules still apply to the Reg D 506(b) as if none of this ever happened.
- Offerings that started prior to the Effective Date of Title II may turn into 506(c) offerings without any additional acts by the investors or issuers.
- SEC views “general solicitation” and “general advertising” to both be considered “general solicitation.”
- Private funds are subject to these same rules.
The preceding document was written by Sam Houghton of Houghton, P.A. It is a summary only and in no way should be considered legal advice. Every situation differs. Please consult your attorney or investment advisor with individual questions.