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GENERAL SOLICITATION UNDER THE NEW RULE 506(c)

posted in Angel Investing, Business Valuation, Capital Raise, Corporate formation, Corporate Governance, Financing, JOBS Act, Private Companies, SEC, SEC Reporting, Securities, Small Businesses, Startups, Venture Capital by

In the wake of the financial crisis and economic downturn Congress enacted the JOBS Act to significantly ease certain securities law requirements in order to facilitate capital formation and job creation. Specifically, Section 201(a) of the JOBS Act required the SEC to eliminate the prohibition on using general solicitation under Rule 506 where all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors.

To accomplish this, the new Rule 506 adds paragraph (c) which permits issuers, including private investment funds, to use general solicitation to engage a larger group of potential investors without engaging in a registered public offering. However, to fall under the protections of Rule 506(c): (i) All purchasers in the offering must be accredited investors; (ii) The issuer must take reasonable steps to verify their accredited investor status; and (iii) Certain other conditions in Regulation D are satisfied.

“Accredited Investor”

For an individual to be classified as an “accredited investor” they must have: (i)Earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year; or (ii) A net worth in excess of $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

“Reasonable Steps to Verify”

Additionally, issuers relying on Rule 506(c) must “reasonable steps to verify” that purchasers are accredited investors. In the Adopting Release, the SEC noted that Rule 506(c) does not require any particular method of verifying accredited investor status; however, the SEC did indicate that “reasonable” is an “objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction.” In evaluating the status of an investor, issuers should consider the following factors: (i) The nature of the purchaser and the type of accredited investor that the purchaser claims to be; (ii) The amount and type of information that the issuer has about the purchaser; and (iii) The nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as whether it requires a minimum investment amount.

Further, the SEC has offered a non-exclusive list of four specific methods for satisfying the verification requirement of Rule 506(c). Issuers employing any of the following methods will be deemed to satisfy the verification requirement, unless the issuer or its agent has knowledge that the purchaser is not an accredited investor:

(i)                 Verifying whether a natural person is an accredited investor on the basis of income through reliance on a combination of tax reporting forms and written investor representations.

(ii)               Verifying whether a natural person is an accredited investor on the basis of net worth through reliance on (a) recent statements from financial institutions, tax assessments, third party appraisals or a recent credit report and (b) related investor representations.

(iii)             By relying upon written confirmation from a registered broker-dealer, an SEC registered investment advisor, a licensed attorney, or a certified public accountant that a person or entity has taken reasonable steps to verify that a purchaser is an accredited investor within the prior three months and has determined that such a purchaser is an accredited investor.

(iv)             With respect to any natural person who invested in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of Rule 506(c), the issuer is deemed to satisfy the verification requirement if, at the time of sale, the purchaser has maintained the prior investment and provides a certification that he/she qualifies as an accredited investor.

The SEC also noted that the means by which the issuer solicits potential investors is relevant in reviewing the appropriateness of the issuer’s evaluation.

 

CONCLUSION

Offerings of securities using general solicitation under Rule 506(c) can be a complicated and tedious topic. Furthermore, for issuers that don’t want to limit the sale of their securities to accredited investors or that would like to conduct an offering without using general solicitationRule 506(b) continues to be available. Either way, the different exceptions, rules and provisions make it an issue that needs to be researched further, if you plan on utilizing it for your business.

If you are interested in learning more about Rule 506(c), and how it may affect you, then please contact Larry Horwitz at lhorwitz@horwitzarmstrong.com.

15 Dec, 15

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