For eight decades, companies wishing to sell private securities had to rely on friends, family, or their own networks because securities laws didn’t allow for general solicitation. The only way was via Rule 506 of Regulation D.
But that changed in September 2013, when Title II of the JOBS Acts came into effect. The Rule 506 exemption was split into two: 506(b) represented the old approach, and 506(c) heralded a new era. Rule 506(c), in keeping with the age of transparency and sharing of information, allows general solicitation or advertising to the public. Beyond the general solicitation restrictions, there are several other key differences between these two rules.
Sophisticated Investors vs Accredited Investors
Companies selling private securities under Rule 506(b) can (but most experts agree that they shouldn’t) sell such securities to accredited investors and up to 35 unaccredited, but sophisticated investors. Determining what, precisely, constitutes a ‘sophisticated investor’ is somewhat open to interpretation and issuers and the SEC may not agree. Under Rule 506(c), companies are required to sell only to accredited investors.
Verifying Accredited Investors
In general, companies will seek to only deal with accredited investors even under Rule 506(b). However, under a 506(b) offering it is permissible for investors to self-verify. Under 506(c), the issuer, or its advisors on its behalf, must take reasonable steps to verify the accredited investor status of each investor. Methods that will satisfy SEC’s ‘reasonable steps’ requirement include a review of tax returns, brokerage or bank statements, verification of net worth, or written confirmation from a broker, attorney, or certified accountant. There are quite of lot of rules, guidance, and nuances to verification, so a detailed analysis of the laws is recommended for anyone that seeks to understand it fully.
Proof of Prior Relationship
There is no proof of prior relationship requirement for issuers relying on a Rule 506(c) exemption. Under a Rule 506(b) offering, issuers must be able to demonstrate that they had a substantive prior relationship with the investor prior to their knowledge of the investment opportunity. In determining whether or not a substantive relationship exists, one would consider the duration of the relationship and the extent of familiarity between the parties.
Rule 506(c) provides companies with the ability to solicit anyone, so long as they ultimately only accept accredited investors who have been verified. As investors become more accustomed to verification, it’s possible that Rule 506(c) offerings will dominate the market for Rule 506 offering in the future. For companies deciding between Rule 506(b) and Rule 506(c), it’s important to note that once you’ve generally solicited your offering, it is then always a Rule 506(c) offering. There’s no going back to Rule 506(b) and pretending that general solicitation never happened.
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