Rule 506(b) Offerings

Rule 506(b)

Rule 506(b) Offerings – Regulation D Offerings

Section 4(a)(2) of the Securities Act of 1933, as amended (the “Securities Act”) exempts from SEC registration, transactions by an issuer not involving a public offering. Rule 506(b) of Regulation D of the Securities Act provides a “safe harbor” under Section 4(a)(2). Rule 506(b) sets forth standards that a company can use to meet the requirements of the Section 4(a)(2) exemption.

Under Rule 506(b), an issuer may raise an unlimited amount of money. Additionally, the issuer can sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors if certain disclosures are provided.

General Requirements of Rule 506(b) Offerings

An offering under Rule 506(b) has the following requirements:

  • no general solicitation or advertising may be used to sell the securities
  • the securities may not be sold to more than 35 non-accredited investors and all non-accredited investors, either alone or with a purchaser representative, must meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment

Rule 506(b) Offerings to Non-Accredited Investors

If non-accredited investors are purchasing in the Rule 506 (b) offering, the issuer must provide non-accredited investors with disclosure documents that generally contain the same type of information as provided in registered offerings, and provide the financial statement information specified in Rule 506.

These financial statements may need to be certified or audited by an accountant.

A company using Rule 506(b) for its offering is not required to provide specified disclosure documents to accredited investors, but, if it does provide information to accredited investors, it must also make this information available to the non-accredited investors as well. Additionally, the company’s management should be available to answer questions from prospective purchasers who are non-accredited investors.

Bad Actor Disqualification in Rule 506(b) Offerings

As a result of Rule 506(d) bad actor disqualification, an offering is disqualified from relying on Rule 506(b) of Regulation D if the issuer or any other person covered by Rule 506(d) has a relevant criminal conviction, regulatory or court order or other disqualifying event that occurred on or after September 23, 2013. Under Rule 506(e), for disqualifying events that occurred before September 23, 2013, issuers may still rely on Rule 506, but will have to comply with the disclosure provisions of Rule 506(e) discussed below.

Covered Persons

Understanding the categories of persons that are covered by Rule 506(d) is important because issuers are required to conduct a factual inquiry to determine whether any covered person has had a disqualifying event, and the existence of such an event will either disqualify the offering from reliance on Rule 506 or will have to be disclosed to investors.

Covered persons” include:

  • the issuer, including its predecessors and affiliated issuers
  • directors, general partners, and managing members of the issuer
  • executive officers of the issuer, and other officers of the issuers that participate in the offering
  • 20 percent beneficial owners of the issuer, calculated on the basis of total voting power
  • promoters connected to the issuer
  • for pooled investment fund issuers, the fund’s investment manager and its principals
  • persons compensated for soliciting investors, including their directors, general partners and managing members

Disqualifying Events

Disqualifying events in Rule 506(b) Offerings include:

  • Certain criminal convictions
  • Certain court injunctions and restraining orders
  • Final orders of certain state and federal regulators
  • Certain SEC disciplinary orders
  • Certain SEC cease-and-desist orders
  • SEC stop orders and orders suspending the Regulation A exemption
  • Suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or from association with an SRO member
  • U.S. Postal Service false representation orders

Many disqualifying events include a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years).  The look-back period is measured from the date of the disqualifying event—in the example, the issuance of the injunction or regulatory order—and not the date of the underlying conduct that led to the disqualifying event.

Reasonable Care Exception

The rule provides an exception from disqualification when the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.

The steps an issuer should take to exercise reasonable care will vary according to particular facts and circumstances.  The instruction to the rule states that an issuer will not be able to establish that it has exercised reasonable care unless it has made, in light of the circumstances, factual inquiry into whether any disqualification exists.


The final rule provides for the ability to seek waivers from disqualification by the Commission.  There are a number of circumstances that could, depending upon the specific facts, be relevant to the evaluation of a waiver request.

Rule 506(d)(2) of Regulation D provides another way for issuers to request a waiver of disqualification.  Disqualification will not arise if, before the relevant sale is made in reliance on Rule 506, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing—whether in the relevant judgment, order or decree or separately to the Commission or its staff—that disqualification under Rule 506 should not arise as a consequence of such order, judgment or decree.

Disclosure of Pre-Existing Events

Disqualification will not arise as a result of disqualifying events that occurred before September 23, 2013, the effective date of the rule amendments.  Matters that existed before the effective date of the rule and would otherwise be disqualifying are, however, required to be disclosed in writing to investors.  Issuers must furnish this written description to purchasers a reasonable time before the Rule 506 sale.  Rule 506 is unavailable to an issuer that fails to provide the required disclosure, unless the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a disqualifying event was required to be disclosed.

Determining whether disclosure is required.  The rule looks to the timing of the triggering event (e.g., a criminal conviction or court or regulatory order) and not the timing of the underlying conduct.  A triggering event that occurs after effectiveness of the rule amendments will result in disqualification, even if the underlying conduct occurred before effectiveness.

Form of disclosure.  The Commission expects that issuers will give reasonable prominence to the disclosure to ensure that information about pre-existing bad actor events is appropriately presented in the total mix of information available to investors.

Tradability and Resales in Rule 506(b) Offerings

A Purchaser in a Rule 506(b) Offering receives “Restricted Securities”.  Rule 144(a)(3) identifies what offerings produce restricted securities. After these offerings, investors can only resell their securities into the market by using an effective registration statement under the Securities Act or an exemption from registration for the resale, such as Rule 144.

Rule 144 permits the resale of restricted securities if a number of conditions are met, including holding the securities for six months or one year, depending on whether the issuer has been filing reports under the Securities Exchange Act of 1934. Rule 144 may limit the amount of securities that can be sold at one time and may restrict the manner of sale, depending on whether the security holder is an affiliate. An affiliate of a company is a person that, directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the company.

Rule 506(b) is only available for offers and sales by an issuer of securities to initial purchasers and is not available to any affiliate of the issuer or to any person for resales of the securities.

Form D Requirements

A company conducting a Rule 506(b) Offering must file a Form D with the SEC within 15 days after the first sale of securities in the offering.

State Law Considerations

Although the Securities Act provides a federal preemption from state registration and qualification under Rule 506(b), the states still have authority to require notice filings and collect state fees. Rule 506(b) offerings are subject to “bad actor” disqualification provisions.

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