Complying with the new Rule 506 Offering Rules

I’ve previously discussed the new Rule 506 offering regulations [codified in Rule 506(c)], which permits general solicitation in connection with a securities offering. However, compliance with this new Rule 506 offering has a few regulatory hurdles, including only making sales to accredited investors, including lengthy legend text specified by the regulations on all solicitation material (even a tweet or Facebook post qualifies), forwarding all copies of general solicitation materials to the SEC, and filing Form Ds (or amendments thereto) both 15 days before solicitation begins *and* 15 days after the first sale (as opposed to only one form 15 days after the first sale); failure to comply can lead to a company being prohibited from using Rule 506 in its entirety for one year.

However, it should be noted that the “old” Rule 506 offering [Rule 506(b)] still remains on the books, so companies can continue to do it the “old way”.

The new Rule 506 also now requires companies to actively verify the accredited status of their investors — self-certification is not enough, with one exception. The SEC provides a list of “safe-harbor” methods for determining accredited status (the list is not exclusive, and companies can use other methods, subject to the approval of the SEC). First, accredited investors from a previous round can self-certify themselves as still qualifying for accredited status (the only exception to the self-certification prohibition). The company can also verify status itself by reviewing either: 1) IRS forms proving income, or 2) bank/brokerage statements and credit reports proving income or net worth. Finally, a company can obtain verification from a third-party, such as a registered broker-dealer, SEC-registered investment advisor, or licensed attorney or CPA.

Some suggest that companies only use third-party verification, rather than trying to do it themselves. Firms are already springing up to provide such services. While the company is ultimately on the hook with the SEC (and any penalties they wish to hand down), the company may be able to steer into the third-party safe harbor, or at the very least obtain limitation of liability and indemnity for losses and damages by contract from the third party.

Furthermore, with the stiff penalties for noncompliance with the new Rule 506 offering, it becomes perhaps more important than ever to avoid accidentally integrating offerings. The securities laws consider two offerings that are temporally close to other another to be actually one big offering. So if your company does an offering with unaccredited investors under the existing Rule 506, or another exemption such as Rule 504, then does a general solicitation offering a couple of months later, securities regulators may consider them one offering and slap you with penalties for selling to unaccredited investors in a general solicitation Rule 506 offering. It is best to keep at least six months in between offerings.

Finally, because general solicitation will be tightly monitored, including both having to send copies of all solicitation materials to the SEC, as well as the existing securities laws prohibiting materially misleading statements, it is best to do what large companies do, and limit communications about the offering to only a key few employees, such as the CEO, CFO, COO, or general counsel (an attorney employed by the company, not an outside firm).

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