Rule 506(c) Accredited Crowdfunding Offering Requirements – Crowdfunding Attorneys
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”). Rule 506 contains two distinct offering exemptions. Rule 506(b) and Rule 506(c). Rule 506 (b) provides an exemption to an unlimited number of accredited investors and up to thirty-five non-accredited investors without the use of general solicitation and advertising while Rule 506(c) allows the issuer to sell to an unlimited number of accredited investors so long as it verifies that each investors is an accredited investor.
The first question most issuers ask when considering an offering under Rule 506 is “what is an accredited investor”?
Under Rule 501 of Regulation D, an accredited investor is any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:
- Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
- Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
- Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
- Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
- Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000. For purposes of calculating net worth the following shall not be included, (i) The person’s primary residence, (ii) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and (iii) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability.
- Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
- Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in §230.506(b)(2)(ii); and
- Any entity in which all of the equity owners are accredited investors.
Laundry List of Methods to Determine Accredited Investor Status
The final rule adopting Rule 506(c) set out a non-exclusive laundry list of ways that issuers may satisfy Rule 506′s accredited investor verification requirement. These include a review of:
- IRS forms such as tax returns for the two most recent years and written representations regarding the investor’s expected income level for the current year;
- Bank statements, brokerage statements and/or tax assessments, to determine assets, and a consumer report or credit report from at least one consumer reporting agency to assess liabilities;
- Written confirmation from a registered broker-dealer, registered investment advisor or CPA; and
- A certification for investors prior to adoption of Rule 506(c).
Can Broker-Dealers use 506(c) to offer and sale securities?
Yes. Broker-Dealers may generally solicit under 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. 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. 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.
Can an Investment Adviser offer the same fund using 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 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 Rule 506(c).
Will investment advisers to private funds be allowed to generally solicit their funds under 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 Rule 506(c).
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.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.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. Please note that the prior results discussed herein do not guarantee similar outcomes.
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Brenda Hamilton, Securities Attorney
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