The Securities and Exchange Commission (SEC) granted a no-action relief on March 12 in response to an inquiry by U.S. law firm Latham & Watkins LLP. This SEC No-Action Letter is expected to increase the adoption of Rule 506(c) by introducing a simplified alternative for investor verification, which in turn will make access to capital easier for companies and private funds.
Background
Rule 506(b) of Regulation D has long been the most frequently used exemption from the registration requirements of the Securities Act of 1933. It allows issuers to raise unlimited funds from an unlimited number of accredited investors and up to 35 unaccredited but financially sophisticated investors without registering the offer and sale of securities with the SEC. However, Rule 506(b) prohibits issuers from engaging in general solicitation or advertising of the offering.
The SEC adopted Rule 506(c) of Regulation D in response to the JOBS Act of 2012. This rule allows issuers to raise unlimited funds from accredited investors through general solicitation and advertising, provided that only accredited investors participate in the offering and the issuer takes reasonable steps to verify their accredited investor status. Rule 506(c) outlines three nonexclusive methods for verifying an investor's accredited status for natural persons: verification based on income, net worth or reliance on a lawyer, broker-dealer or accountant letter. If all conditions of the rule are met, the issuer is permitted to spread the news about its offering across a wide variety of media outlets, including the internet.
However, Rule 506(c) has seen limited adoption due to its burdensome investor verification requirements and the risk that issuers may inadvertently lose their exemption if they accept funds from even one unverified investor. According to the 2024 Annual Report from the SEC’s Office of the Advocate for Small Business Capital Formation, companies raised $170 billion under Rule 506(b) in fiscal year 2024, compared to only $12 billion under Rule 506(c). Pooled funds raised $1.7 trillion under Rule 506(b) versus $125 billion under Rule 506(c).
The New Rules
The SEC has agreed that an issuer can reasonably conclude they have taken reasonable steps to verify an investor's accredited status if:
- The issuer obtains written representations from the investor stating (a) the investor is an accredited investor, and (b) the investment is not financed in whole or in part by any third party specifically for the purpose of making the investment in the issuer.
- The minimum investment amount is at least $200,000 for natural persons or $1 million for entities.
- The issuer has no actual knowledge that the written representations are untrue.
Importantly, issuers can still rely on traditional verification methods for smaller investments.
The same framework applies to fund formation. Emerging fund managers can now rely on Rule 506(c) when raising capital from prospective limited partners, provided the minimum commitment amounts are $200,000 per individual or $1 million per entity. By incorporating the required representations into their subscription documents, emerging fund managers can expand their reach to a broader pool of prospective LPs without risking their offering exemption.
Conclusion
This streamlined approach to investor verification is expected to make compliance with Rule 506(c) easier, encouraging broader adoption of general solicitation and advertising in private placements.
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