A Guide to Rule 506(b) of Regulation D

Whether a publicly or privately held company, you are expected to be familiar with federal securities laws. Any company that sells stock or partial ownership in the business must register with the SEC or meet an exemption. These exemptions are set forth in Regulation D of the Securities Act. Two exemptions, in particular, Rule 506(b) and 506(c), require investors partaking in a Reg D offering to meet certain requirements for compliance sake, which we will dive deeper into below.

Let’s back up for a minute and dive into what Rule 506(b) of Regulation D is and why it matters.

What is Regulation D?

Under federal securities laws, any offer or sale of a security must either be registered with the SEC or meet an exemption. Regulation D under the Securities Act provides a number of exemptions from the registration requirements.

Smaller private companies can benefit from Regulation D as it enables them to access capital from investors without shouldering the costs and efforts of SEC registration. Reg D is also beneficial to accredited investors who qualify to invest in such offerings.

Although companies who go through a Reg D offering aren’t subject to registering with the SEC, they still have to meet other strict standards for transparency, which help protect investors from fraud.

What is Rule 506(b)?

Rule 506 is a segment of Regulation D under the Securities Act that enables issuers of a Reg D offering to raise an unlimited amount of money. In order to do so, they must meet one of two exemptions outlined in Rule 506(b) and Rule 506(c). The biggest difference between these two is companies cannot generally solicit or advertise with Rule 506(b), besides that, under Rule 506(b), investors may self-certify their accredited investor status. Essentially Rule 506(b) requires substantive pre-exist relationships with your investors.

Rule 506(b) states that issuers may sell to an unlimited number of accredited investors, but to no more than 35 non-accredited investors. This is to ensure that any investors taking part in the private offering are financially sophisticated and able to withstand the risk of loss. Any non-accredited investors who take part in the offering (up to 35 people) must also have sufficient knowledge and experience in financial and business matters to evaluate the investment.

Additionally, under Rule 506(b), the issuer has discretion as to what to disclose to accredited investors. However, if the issuer accepts investments from non-accredited investors, it is required to disclose financial statements and other information about the business to those investors, in fact, not many issuers would accept investments from non-accredited investors due to the potential compliance liabilities.

Screening of accredited investors under Rule 506(b) is generally conducted through an accredited investor survey. If you fail to properly verify even one investor, the entire securities offering may be considered illegal. Hiring a law firm to perform the review is expensive, but performing the review by untrained personnel can be time-consuming and inaccurate. Outsourcing the verification process to a third party is a good idea, and fortunately, we now offer Rule 506(b) investor verification services.

Having a full understanding of these Rules and the investor accreditation program is essential if you hope to solicit funds through private offerings or become an accredited investor yourself.

Understanding is just the first step in the process, though. In order to comply with Rule 506(b), it’s essential to screen investors to ensure they are qualified accredited investors. With Verify Investor, you can outsource the screening process without having to pay unnecessary attorney fees. For more information please reach out to us for Rule 506(b) compliance using our custom verification solution.