Rule 506(c) fundamentally changes how private placements will be conducted, by allowing issuers to engage in general solicitation and advertising if they comply with the Rule’s specific requirements. The advantages offered by Rule 506(c) are significant for issuers who comply with its inflexible but adaptable requirements. In order to ensure smooth sailing and compliance with the new rule, issuers should understand certain basic requirements of the exemption.
The Checklist below sets forth the most significant items the issuer should know about Rule 506(c).
Rule 506(c) Is Not Forgiving
Rule 506(c) has stringent requirements. The Rule is not forgiving for issuers who engage in general solicitation but fail to comply with its requirements. An issuer’s sale to even one non-accredited investor will prevent the issuer from relying upon the exemption.
Rule 506(c) Offerings Are Not Yet Allowed Until September 23
Rule 506(c) will become effective September 23. Until such time, general solicitation and advertising of private placment offerings remains illegal.
Issuers Can Continue to Use Existing Rule 506 After September 23
After September 23, issuers may still rely on existing Rule 506 to raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 nonaccredited investors without general solicitation and advertising. On September 23, old Rule 506 will become Rule 506(b).
Sales May Only Be Made to Accredited Investors
If the issuer will use general solicitation or advertising in connection with the Rule 506 offering, sales of the securities may be made only to accredited investors. Offers can be made to any investor, but the issuer may only makes sales to investors who are accredited.
Issuers cannot conduct similtaneous offerings under both Rule 506(b) and Rule 506(c).
Issuers conducting ongoing Rule 506 Offerings to non-accredited investors prior to September 23, can rely upon Rule 506(c) on September 23, and may use general solicitation and advertising to conduct their offerings so long as sales are only made to accredited investors after the effective date of the rule.
Bad Actors Not Allowed
Issuers will not be able to rely upon Rule 506 if either the issuer or its officers, directors, managing members, owners holding more than 20 percent of its equity securities, placement agents, finders have been subject to certain disqualifying events, unless the it can establish that it did not know and, “in the exercise of reasonable care, could not have known” about the bad actor disqualification. This bad-actor disqualification applies to offerings made under Rule 506 regardless of whether the issuer engages in general solicitation and advertising.
For Bad Actors Only Applies to Bad Actors After Effective Date
If the issuer or its affiliates were subject to a disqualifying bad actor event prior to September 23, the issuer can still rely on Rule 506, but must make disclosure to investors prior to the sale of securities about the disqualifying event.
Securities that are offered, sold and issued in Rule 506 offerings are considered “covered securities” under state blue sky laws regardless of whether the issuer engages in general solicitation and advertising is used.
Verification Of Accredited Investor Status Is Requiired
Rule 506(c) requires that issuers take reasonable steps to verify that Rule 506(c) investors are accredited. The SEC has indicated that accredited investor status will be an objective determination by the issuer based upon the particular facts and circumstances. The SEC provided the non-exlusive methods of satisfying this requirements set forth below:
Income Requirement - The issuer should review tax forms, including W-2s, 1099s, K-1s, and 1040s, that report the purchaser’s income for the two most recent years. The issuer should also obtain written representations from the investor that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year.
Net Worth Requirement Assets - The issuer should review bank, brokerage and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports that are no more than 3 months old.
Liabilities – The issuer should obtain reports from credit agencies. The reports would need to be dated within the prior three months. The issuer should obtain written representations from the investor that all liabilities necessary to make a determination of net worth have been disclosed.
Third Party Confirmations - The issuer should request written confirmations from third parties such as broker-dealers, investment advisers, attorneys and certified public accountants, that such third party has taken reasonable steps within the prior three months to verify that the purchaser is an accredited investor.
Existing Investors – The issuer should ensure that accredited Investors who purchased prior to September 23 should certify that he or she remains an accredited investor.
If an Issuer fails to comply with Rule 506(c)’s requirements, investors have an automatic right of rescission.
For further information about this article, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, or visit http://www.securitieslawyer101.com
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Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 N
Boca Raton, Florida 33432
Telephone: (561) 416-8956
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