Is Rule 506 General Solicitation a Bust?

A recent Forbes article pointed out that the Rule 506(c) exemption authorized by the JOBS Act has been less utilized than initially predicted. Rule 506(c) permits companies to make a general (public) solicitation of securities being sold in a private offering under Regulation D. The catch with Rule 506(c) is that all sales must be made to accredited investors (whereas old Rule 506 — now Rule 506(b) — permits a limited number of sales to non-accredited, sophisticated investors). More importantly, companies must take “reasonable steps” to verify the accredited status of purchasers, whereas the standard practice under Rule 506(b) had purchasers self-certify their accredited status. The SEC provided several “safe harbor” methods that it deemed met the “reasonable steps” standard, most of which involve the investors providing financial records. However, many angel investors are less than eager to have their financial records reviewed, especially by the selling company, but even by attorneys, accountants, or brokers, as also permitted under the safe harbors. The SEC was very clear that its safe harbors were not an exclusive list of “reasonable steps”, and invited issuing companies to come up with new methods of verification under the “principles-based methodology” (which looks at the particular facts and circumstances of an offering, subject to the approval of the SEC. Of course, not many companies are willing to jeopardize their fundraising round by using a verification method that is ultimately rejected by the SEC. The Angel Capital Association has been working on a PBM that allows for verification of investors by their membership in an “established angel group” — the process would define criteria for angels to join an EAG, and a certification method for angel groups to become EAGs. The benefit of such a method is that issuers look at an investor’s membership, rather than their financial records. As the Forbes article points out, many companies are being advised and are electing to either stick with the safe harbor methods, rather than utilize a new method that may ultimately be rejected by the SEC, or avoid general solicitation altogether. I would personally advise companies looking to utilize Rule 506(c) to use the safe harbor methods only, unless and until the SEC officially upholds another method as meeting the verification standards. Although, as the article concludes, general solicitation will become more utilized as the market become more accustomed to certain processes (such as the processes developed for old Rule 506 private offerings), it could be helped along if the SEC were to provide a mechanism for authorizing new methods for verification, such as endorsing methods as they are developed and used, ideally one easier and more definite than a no-action letter. Further reading:

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