On July 10, 2013, the Securities and Exchange Commission (the “SEC”) adopted a new rule that implements a part of the JOBS Act. This rule lifts the ban on general solicitation and advertising with respect to certain types of securities offerings. The new rule 506(c) went into effect on Monday, September 23rd. Here is what you need to know about it, if you would like to adverse your offering to the general public and through the means of general solicitation. 1. All investors must be accredited. Unlike Rule 506(b), this new Rule only allows accredited investors to participate in the offering. Who are accredited investors? These are individuals who have earned income over $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 has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence). A bank, partnership, corporation, a nonprofit, an LLC or a trust can also be accredited investors as long as they satisfy certain tests. The full definition of accredited investor is available here. 2. Take “reasonable” steps to verify the accredited status of your investors. Under the new Rule, it is no longer enough to have the investors fill out an eligibility questionnaire. What steps are “reasonable”? This is determined in the context of each offering, looking at the particular facts and circumstances of each prospective purchaser and transaction. Rule 506(c) provides a non-exclusive list of verification methods that companies can use when looking to verify the individual investors’ accredited status, including:
You should keep very good records that can provide that you have taken reasonable steps to verify the accredited status of your investors. 3. Check a new box that was added to Form D. It is important to remember that if a Rule 506(c) fails, the company cannot simply switch to using Rule 506(b) or Section 4(2) private placement because Rule 506(b) or Section 4(2) do not permit general solicitation or advertising. 4. Make sure that the offering is not disqualified under the new bad actor disqualification provisions in Rule 506(d). Note the list of persons covered by these provisions is very broad and includes:
Under the final rule, a “disqualifying event” includes any of the following: Criminal convictions in connection with the purchase or sale of a security, making of a false filing with the SEC or arising out of the conduct of certain types of financial intermediaries;
There is an exception from disqualification where an issuer can show 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, so due diligence with respect to all covered persons participating in a Rule 506 offering is necessary. Such due diligence may include questionnaires and representations from certain participants, and may also include background checks. Disqualification under Rule 506(d) only applies to disqualifying events occurring after September 23, 2013. Disqualifying events that occurred before the effective date of the rule must be disclosed to investors. In conclusion, remember that if you are not yet ready to conduct an offering under the new Rule 506(c), you can always conduct a private placement under the old Rule 506(b) that remains unchanged. Although that Rule does not allow general solicitation or advertising, it is not limited to accredited investors only (up to 35 sophisticated purchasers can participate) and the issuer does not have to take “reasonable” steps to ensure the accredited status of its investors. Also, keep in mind that the new Rule may still change. The SEC has proposed more rules (the comment period on those expires on September 23rd) that may add complexity to Rule 506(c), such as advance Form D filings, legends, filings of offering materials with the SEC, among others.
Read more commentary from Arina Shulga on the legal aspects of operating new and growing businesses at Business Law Post.
This article is not a legal advice, and was written for general informational purposes only.
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