Old Rule 506 - Regulation and Licensing Department

New Rule 506(c): SEC Opens
Door to Raise Capital Through
General Advertising
Effective September 23, 2013
Congress loosened certain securities requirements
to promote capital formation and job creation,
Rule 506(c) (rule effective 9/23/2013)
 Crowdfunding (rules pending)
Rule 506(c), allows sales to accredited investors through
general solicitation to the public.
 States are preempted to conduct merit review of offering.
 States retain anti-fraud jurisdiction, and possibly over BDs or
finders if compensation is tied to the transaction.
Currently, three rules exempt offerings from
registration requirements.
Rules 504 and 505 were established to help small
business raise capital with offering sizes limited to $1
- $5 Million.
Rule 506 has no limit on offering size, but – unless
the new 506(c) is used – an issuer can’t advertise to
the general public.
In 2012, private offerings under Rule 506
offerings resulted in over $173 billion of capital
raised by operating companies.
Median 506 offering is $1 million.
Rule 506 is the most widely used registration
exemption (approximately 99% of capital
raised under Regulation D from 2009-2012).
Current Rule 506:
No limit on offering size;
Sales to an unlimited number of accredited investors
and up to 35 non-accredited investors who the issuer
reasonably believes can evaluate the offer’s merits
and risks;
No general solicitation, thus registered BDs or
“finders” may assist the issuer in placement efforts
(i.e., locating investors).
General Solicitation includes, “any
advertisement, article, notice or other
communication published in any newspaper,
magazine, or similar media or broadcast over
television or radio" or "any seminar or meeting
whose attendees have been invited by any
general solicitation.” Rule 502(a).
The SEC has interpreted general solicitation to
include unrestricted websites.
In response to JOBS Act, on July 10, 2013, the
SEC eliminated the prohibition against general
solicitation in Rule 506(c) offerings.
Rule 506(c) becomes effective September 23, 2013.
Solicitation / advertising can be to anyone, but
sale only to accredited investors.
Under Rule 506(c), a company or private fund
may use general solicitation in its offering,
1. all sales are made to accredited investors;
2. the company takes reasonable steps to verify the
purchaser is an accredited investor; and
3. Comply with Rule 501, 502(a) and 502(d)
 definitions, conditions, resale limitations.
Another amendment disqualifies an issuer from relying Rule 506
if the issuer or certain related parties are a bad actor (discussed
An issuer can choose which exemption it wants to use.
 506(b) Remains.
506(b) allows an offering without general solicitation.
 Benefits of 506(b), include:
 No need to take reasonable steps to verify whether the
purchaser is an accredited investor.
 Less expense than 506(c).
However, if general solicitation under the “new” 506(c) is
used, there is a six-month "cooling off" period before the
issuer can undertake an offering to non-accredited investors
under the “old” 506(b).
Note: Item 6 on Form D has a box for “(c)” offerings.
 Issuer or private fund can’t use both (b) and (c) in one offering.
New 506(c) - Form and content of an offering is
relatively open, though communications are
still subject to anti-fraud rules;
Meaning: issuer shouldn’t make promises it can’t
For resale purposes, use of a general
solicitation doesn’t convert privately issued
securities into “public offerings”.
Securities issued under Rule 506(c) are still
“restricted securities”.
“Accredited investor” is defined in Rule 501(a):
For an individual to qualify as an accredited
investor, issuer must reasonably believe that the
investor: (1) has a net worth of at least $1,000,000,
excluding the value of their primary residence; or (2)
has income of at least $200,000 each year for the last
two years (or $300,000 together with his or her
spouse, if married) and have the expectation to make
the same amount in the current year.
 Other accredited investors may based on their status:
BDs, investment companies, employee benefit plans.
Two ways to verify: objective standard or selecting one of four
safe harbors.
Objective standard is used to determine if a purchaser is an
accredited investor by considering the particular facts and
circumstances of each purchaser and transaction:
 Issuer should consider:
 The nature of the investor and the type of accredited investor that
the investor claims to be;
 The amount of information the issuer has about the investor;
 The nature of the offering (for example: an unrestricted website
offering may require additional due diligence, while a high
minimum investment amount could indicate the investor’s net
worth / income).
Four safe harbors to verify that individuals (natural
persons) are accredited, (unless issuer knows the
individual is not an accredited investor):
1. Income: verifying through reliance on combination of tax
reporting forms and written investor representation
 Tax docs showing income (W2 / 1099) and return (1040) for two most recent
years and a written statement that the investor reasonably expects to meet
the requisite income level for the current year.
2. Net Worth: verifying through reliance on (i) recent statements
from financial institution, tax assessments, and third party
appraisals or recent credit report and (ii) written statement that all
liabilities have been disclosed.
3. Third party confirmation. Verification by relying on
written confirmation from a registered BD, SEC
registered IA, licensed attorney, or CPA, and that the
third party took reasonable steps to verify the purchaser
is an accredited investor within past three months and
has determined that such a purchaser is an accredited
4. Prior dealings. Verification based certification that
the investor participated in the same issuer’s prior
506(b) offering.
The means by which an offering is made is relevant in
reviewing the reasonableness of the issuer’s evaluation
(more steps may be required for a Facebook or Twitter
solicitation that a pre-screened pool).
BDs have experience screening investor suitability.
Third-party online accredited investor verification services
have already surfaced:
 The Securities Division does not endorse these sites. An issuer is
responsible for taking reasonable steps to verify whether a purchaser is
accredited investor.
For issuers:
 High minimum investment amounts may mitigate
need for additional verification.
 Investor questionnaires – i.e., “what is your net
worth” - are not sufficient verification.
 Record retention is a necessity.
 Concerns with unregistered finders:
Employees of private funds may run afoul of regulatory
agencies by:
 Engaging in business of effecting transactions in securities
for the accounts of others, especially if compensation tied to
Securities issued under all 506 exemption are
preempted from state securities or “blue sky” laws
with respect to merits and qualification of the
State laws requiring BDs and IAs to be registered
are not preempted.
Section 201 of the JOBS Act provided a limited
registration exemption for intermediaries of 506 offerings,
however, their compensation cannot be transactionbased.
 Thus, issuers relying on the 506(c) exemption should
consult with each state in which investors will be solicited
to determine whether the solicitor must be registered or is
Generally, IAs with assets under management
below $100 Million are state regulated.
Common for IA to use 506 offerings
Because of 506(c) allows internet offerings, the
offering may reach into other states (as
compared to 506(b)).
Unclear whether IAs using 506(c) will have to
registered in each state and DC.
Issuers / private funds should consult with
each state where investors may be solicited.
New Rule 506(d) prohibits issuers from relying
on Rule 506 exemption if the issuer or certain
related persons are bad actors:
Related persons whose bad acts can disqualify
an issuer include:
Directors, executive officers, GP's or managing
20% beneficial owners
Certain promoters, investment managers, placement
agents and their controlling persons.
Start-up companies can solicit funds on social
Established private companies can raise capital
without the assistance of an investment banker.
Facilitates capital formation.
Verification process may deter investors
because of privacy concerns.

similar documents