SEC adopts rules eliminating the prohibition against general solicitation and advertising in Rule 506 offerings to accredited investors

by Saul Ewing Arnstein & Lehr LLP


On July 10, 2013, the Securities and Exchange Commission (the “Commission”) amended Rule 506 of Regulation D to permit an issuer to engage in advertising or general solicitation in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors. The Commission was obligated to implement this rule under Section 201(a) of the Jumpstart Our Business Start Ups Act. The goal of the rule is to facilitate issuers in capital formation by making it easier for entrepreneurs to connect with accredited investors that are willing to invest in their businesses. The new rule will become effective sixty days after the date on which it is published in the Federal Register, which should be on or around September 20, 2013.

The new rule allows issuers to use, among other techniques, newspaper and radio advertising, television and radio broadcasts, mailings, live seminars and websites to locate potential investors. Previously, issuers were not permitted to use these solicitation methods and were limited to offering securities to potential investors with whom they had a preexisting relationship or who were referred to them by a registered broker-dealer for a fee. Investor advocates have expressed concern that removing these limitations will result in a dramatic increase in fraud and other abuses. To address this concern, the Commission has also adopted an additional new rule that disqualifies criminals and other bad actors from using Rule 506 to complete securities offerings.

The new Rule 506(c) requires that issuers satisfy the following conditions in order to qualify for the general solicitation exemption:

  • all terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied;
  • all purchasers of securities must be accredited investors; and
  • the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors.

Issuers will continue to have the ability to conduct Rule 506 offerings subject to the prohibition against general solicitation by relying on Rule 506(b). There is no amendment or modification to the requirements relating to the existing Rule 506(b). For an ongoing offering under Rule 506 that commenced before the effective date of Rule 506(c), the issuer may choose to continue the offering in accordance with the requirements of either Rule 506(b) or Rule 506(c). If the issuer continues the offering in accordance with Rule 506(c), any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales of securities that occurred prior to the effective date in reliance on Rule 506(b).

In satisfying the verification requirement, whether the steps taken by an issuer are “reasonable” will be an objective determination by the issuer in the context of the particular facts and circumstances of each purchaser and transaction. In completing this analysis, issuers should consider:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • 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 a minimum investment amount.

After considering these factors, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer will need to take to verify accredited investor status, and vice versa. Issuers will need to retain adequate records regarding the steps taken to verify that a purchaser was an accredited investor.

With regard to the nature of the purchaser and type of accredited investor that the purchaser claims to be, if an issuer has actual knowledge that the purchaser is an accredited investor, the issuer will not have to take any verification steps at all. If an issuer is verifying that an entity is an accredited investor by virtue of being a registered broker-dealer, the issuer can verify that status by locating the entity on FINRA’s BrokerCheck website. In order to check compensation levels for individuals trying to meet the income test of Rule 501(a)(6), an issuer can rely on publicly available information in filings with a federal, state or local regulatory body, or third party information that provides reasonably reliable evidence, for example, pay stubs from an employer or published industry compensation standards of persons of the purchaser’s seniority. In addition, verification by a third party may be sufficient if the issuer has a reasonable basis to rely on such third-party verification.

With regard to the amount and type of information that the issuer has about the purchaser, an issuer that solicits new investors through a website accessible to the general public, through a widely disseminated email or social media solicitation or a newspaper ad, will likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party.

With regard to the nature and the terms of the offering, an offering with a high minimum investment amount could be a relevant factor in the issuer’s evaluation of the reasonableness of verification of a purchaser’s status as an accredited investor. It will often be unlikely for purchasers who are not accredited investors to meet high minimum investment amounts.

In addition to the principles-based method of verification described above, the Commission adopted four specific non-exclusive methods of verifying accredited investor status for natural persons that are deemed to satisfy the verification requirement in Rule 506(c).

  1. Natural Persons Using the Income Test of Rule 501(a)(6): An issuer can review copies of any Internal Revenue Service (“IRS”) form that reports income (Forms W-2, 1099, K-1, 1040) for the two most recent years and obtain a written representation from such person that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor in the current year. If qualifying under the joint income test, the purchaser should provide reports and a written representation from his or her spouse as well.
  2. Natural Persons Using the Net Worth Test of Rule 501(a)(5): An issuer can review asset statements (bank statements, brokerage statements and other statements of securities holdings, CDs, appraisal reports issued by third parties) and liability reports (credit reports from at least one of the nationwide consumer reporting agencies) dated within the prior three months as well as a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed to the issuer. Personally identifiable information on these reports is permitted to be redacted.
  3. Written Confirmation from a Third Party: A written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has verified that such purchaser is an accredited investor.
  4. Written Certification By Existing Investors: 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) and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement with respect to any such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

Issuers relying on the new Rule 506(c) must indicate on Form D that they are relying on this exemption by marking the new check box in Item 6.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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