Rule 506 Offerings FAQ By: Brenda Hamilton Attorney

Securities Lawyer 101 Blog

Rule 506 Offerings are the most common of the Regulation D exemptions from registration under the Securities Act of 1933, as amended (the “Securities Act”).   It has been approximately a year since the Securities and Exchange Commission (the “SEC”) adopted new criteria for Rule 506 offerings. Under the new rules, issuers may use general solicitation and advertising in their securities offerings if certain conditions are met.  The SEC’s new rules also create “disqualifying events” for “covered persons” which prevent the issuer from relying on the Rule 506 exemption.

This blog post addresses the most common questions we received over the last year from our clients about the JOBS Act’ and its changes to Rule 506.

How has Rule 506 changed since the JOBS Act?

The JOBS Act created two different types of offering exemptions under Rule 506.  A new exemption under Rule 506(c) was created and the previous Rule 506 exemption became Rule 506(b).  While Rule 506(c) is still considered to be a private placement it is a public offering made only to “accredited investors”.  506(c) offerings can be widely advertised by the use of any media including the internet,  billboards and television BUT sales can only be made to investors whose status as an accredited investor has been verified.    Issuers may still rely on Rule 506(b) to conduct an offering without the use of general solicitation and advertising and sell to up to 35 non‐accredited investors. In Rule 506(b) offerings, no accredited investor verification is required.

Can my company still conduct a Rule 506(c) offering prior to completion of a going public transaction?

Yes, both private and public companies can rely upon Rule 506(c).

What is an “accredited investor”?

Accredited investors is an investor with a net worth (excluding their primary residence) of $1 million, income of $200,000 a year (or $300,000 with their spouse), officers and directors of the issuer and certain institutions that have more than $5 million in assets.

Can Broker-Dealers use 506(c) to offer and sale securities?

Yes. Broker-Dealers may generally solicit under new Rule 506(c), provided that the following conditions are satisfied:

i. all terms and conditions of Rule 501 and Rules 502(a), which relates to integration of offerings, and 502(d), which relates to resale restrictions, must be satisfied;
ii. all purchasers of securities must be accredited investors; and
iii. the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors.

Broker-dealers participating in offerings in conjunction with issuers relying on the Rule 506(c) registration statement exemption remain subject to the rules of the Financial Industry Regulatory Authority (“FINRA”) concerning public communications. These rules include generally, among other things, (i) generally require all member communications to be based on principles of fair dealing and good faith, to be fair and balanced, and to provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry or service; and (ii) prohibit broker-dealers from making false, exaggerated, unwarranted, promissory or misleading statements or claims in any communications. See FINRA Rule 2210.

Are there any special implications for a broker-dealer and its salespersons that participate in offerings exempt under Rule 506(c)?

Rule 5123 requires that FINRA members that sell securities in a Rule 506(c) offering must (i) submit to FINRA a copy of any private placement memorandum, term sheet or other offering document, including any materially amended versions thereof, used in connection with such sale within 15 calendar days of the date of first sale; or (ii) notify FINRA that no such offering documents were used.

Additionally, salespersons of broker-dealer firms must ensure their firm has authorized their participation in the offering.

Are securities sold under Rule 506(c) considered covered securities under the National Securities Markets Improvement Act (“NSMIA”)?

Yes. New Rule 506(c) offerings are considered covered securities under NSMIA. However, issuers must look to each state where they offer or sell their securities to determine any applicable notice filing requirement(s). Issuers should also be aware that the anti-fraud provisions of both federal and state laws still apply to covered securities.

Can Issuers relying on Rule 506(c) allow investors to “check the box” indicating that they are an accredited investor?

No. New Rule 506(c) permits issuers and broker-dealers to use general solicitation and general advertising to offer their securities provided that (i) the issuer takes reasonable steps to verify that the investors are accredited investors and (ii) all purchasers of the securities fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.

The determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each purchaser and the nature of the offering.

Did the SEC provide any acceptable methods to verify accredited investor?

The SEC has specified four specific non-exclusive methods of verifying accredited investor status that satisfy the accredited investor verification requirement of Rule 506(c). These methods will not be deemed to satisfy the verification requirement, however, if the issuer or its agent has actual knowledge that the purchaser is not an accredited investor.

These methods of verification are set forth in Rule 506(c)(2)(ii).

Can an Investment Adviser offer the same fund using new Rule 506(c) and traditional Rule 506(b) so long as they ensure that any investor contacted through general solicitation is an accredited investor?

No. An issuer must either check the box for a Rule 506(b) offering or a Rule 506(c) offering. They cannot select both Rule 506 exemptions. Under new Rule 506(c) all purchasers of the securities must fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer must reasonably believe that the investors fall within one of the categories at the time of the sale of the securities. Once a general solicitation has been made to the purchasers in an offering, an issuer is not able to rely on Rule 506(b). Accordingly, a fund must either be sold in compliance with 506(b) or new Rule 506(c).

Will investment advisers to private funds be allowed to generally solicit their new funds under new Rule 506(c)?

Yes. Section 201(b) of the JOBS Act permits offers and sales of securities under Rule 506(c) by private funds relying on the exclusions from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. Accordingly, starting September 23, 2013, private fund advisers may generally solicit the sale of interests in their newly formed funds.

However, please note that private funds engaged in activities regulated by the U.S. Commodity Futures Trading Commission (the “CFTC”), will need to examine whether there are available exemptions before engaging in a Rule 506(c) offering. The CFTC has not yet reconciled their rules, which affect whether certain commodity pool operators (CPOs) will be deemed to be “marketing to the public” as contemplated in certain CPO regulations and exemptions, with the new Rule 506(c).

How does the removing the ban on general solicitation apply to Rule 144A offerings?

Pursuant to amendments to Rule 144A, securities offered pursuant to Rule 144A are permitted to be offered to persons other than qualified institutional buyers, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are qualified institutional buyers.

We have had an ongoing offering under the prior version of Rule 506. Can we now expand the offering to include general solicitation under Rule 506(c)?

Yes. For an ongoing offering under Rule 506 that commenced before September 23, 2013, the issuer may choose to continue the offering in accordance with the requirements of either Rule 506(b) or Rule 506(c). If an issuer chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after September 23, 2013 will not affect the exempt status of offers and sales of securities that occurred prior to September 23, 2013 in reliance on Rule 506(b).

Can an issuer rely on a third party to verify a person’s status as an accredited investor?

Yes, an issuer will be entitled to rely on a third party that has verified a person’s status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification.

Where are the rules about the disqualification provisions Rule 506 located and when do the disqualification provisions  apply?

Rule 506(d) of Regulation D contains the bad actor disqualification rule. Under Rule 506(c) Covered Persons are generally: the issuer; each affiliated issuer and each predecessor to the issuer, each remunerated solicitor; the general partner, managing member or investment advisor (in the case of a pooled investment fund issuer) of the issuer and each such person or entity; each officer participating in the offering, executive officer and director of all of the foregoing; each holder of 20 percent or greater voting equity of the issuer; and each promoter connected in any capacity with the issuer at the time of sale.

Disqualifying events include:

i. Criminal convictions; injunctions; restraining, final, disciplinary, cease and desist, stop, suspension and false representation orders indicative of fraud, deception, misrepresentation or non-compliance with federal or state laws, regulations or agency rules regulating securities, financial institution, insurance, and commodities futures trading activities; related misrepresentations to the US Postal Service; and

ii. Suspensions and expulsions from membership in, and suspensions and bars from association with, members of certain securities industry self-regulatory organizations, such as FINRA.

If a Disqualifying event occurs after September 23, 2013, then the issuer is not allowed to rely upon Rule 506 for its securities offering.   If the Disqualifying event was before September 23, 2013, Rule 506(e), requires the issuer to disclose written information about the event to each investor a reasonable time prior to his or her investment.

For more information about this blog please contact Brenda Hamilton, securities attorney at bhamilton@securitieslawyer101.com.

This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. For more information about going public and the rules and regulations affecting the use of Rule 144, Form 8K, crowdfunding, FINRA Rule 6490, Rule 506 private placement offerings and memorandums, Regulation A, Rule 504 offerings, SEC reporting requirements, SEC registration statements on Form S-1 , IPO’s, OTC Pink Sheet listings, Form 10 OTCBB and OTC Markets disclosure requirements, DTC Chills, Global Locks, reverse mergers, public shells, direct public offerings and direct public offerings please contact Hamilton and Associates at (561) 416-8956 or info@securitieslawyer101.com. Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
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Boca Raton, Florida 33432
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