May 8, 2017

Regulation D Rule 506(c)

THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY. THIS DOCUMENT IS NOT TO BE CONSTRUED AS LEGAL ADVICE.

With the passage of the JOBS Act in 2012, one of the most exciting developments was the addition of rule 506(c) to Regulation D.

Under 506(c) as opposed to 506(b) and most other private exemptions, a company can broadly solicit, generally advertise, and raise an unlimited amount of capital if the following conditions are met:

  1. The investors in the offering are all accredited investors; and
  2. The company takes “reasonable steps” to verify that its investors are accredited.

These are obviously both departures from 506(b) where you are allowed up to 35 unaccredited investors and you can more so rely on investor self-certification as to their status as accredited or not.

Similar to 506(b) as discussed last week, 506(c) preempts state law. In other offering exemptions, you must be particularly careful you are not only following the federal exemption, but also the states securities regulations as well. What federal preemption means in terms of 506(c) is that as long as you are in compliance with the federal regulation, you are in compliance with the states’ regulations as well.

Issuers should be filing Form D with the SEC (your attorney should handle this). Typically, the only state requirement is a notice filing with a copy of Form D and a filing fee in each state an investor resides in (New York is the exception to this rule as their requirements are more onerous).

Issuers are not even required to have their advertisements submitted or approved by the SEC. Be very careful though, fraudulent or misleading statements in advertisements could lead to civil penalties and even criminal charges.

Another major benefit of this offering is that so long as it is a legitimate offering (not merely being done to circumvent the rules), you can utilize the substantive relationships you develop via a 506(c) offering in future 506(b) offerings for forthcoming deals.

Below we will discuss the SEC’s interpretation of conducting “Reasonable Steps” and how an issuer can go about verifying accredited status.

 

Reasonable Steps

“Reasonable steps” are to be determined in the context of the particular facts and circumstances of each purchaser and transaction. The SEC released a nonexclusive list of factors an issuer should consider when determining the reasonableness such as: (1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (2) the amount and type of information that the issuer has about the purchaser; and (3) the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

Income Requirement

When attempting to qualify an investor as accredited via the income requirement the SEC has recommended issuers conducting due diligence by reviewing the following non-exclusive list of documents: (1) W-2’s; (2) 1099’s; (3) K-1’s; (4)1040’s; and (5) any other documentation that reports the investor’s income the previous two years. The SEC also requires obtaining a written representation from the investor that he or she has a reasonable expectation of reaching the requisite income level to qualify as an accredited investor.

Net Worth Requirement

When attempting to qualify an investor as accredited via the net worth requirement the SEC has recommended obtaining the following documentation dated within the previous three months for assets: (1) bank statements; (2) brokerage statements; (3) other statements of securities holdings; (4) certificate of deposits; (5) tax assessments; and (6) appraisal reports issued by independent third parties. For liabilities the SEC has required obtaining a credit report from at least one of the nationwide consumer reporting agencies. Also required is a written representation from the investor that liabilities necessary to make a determination of net worth have been disclosed.

Third Party Verification

An issuer can be deemed to have satisfied the verification requirement of 506(c) by obtaining a written confirmation from: (1) a registered broken dealer; (2) an SEC-registered investment adviser; (3) a licensed attorney; or (4) a certified public accountant. This written confirmation must state that such person or entity has taken reasonable steps to verify the investor is accredited within the prior three months and has determined that such investor is accredited

Previous Investors

Any natural person who invested in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of Rule 506(c) (September 23, 2013) and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement in Rule 506(c) with respect to any such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.

 

If you have any questions, please feel free to contact us at the number listed above.

17101 Preston Road, Suite 110, Dallas, Texas 75248
Telephone: 469-398-2780
Facsimile: 469-398-2777
Contacts:
Merrill L. Kaliser (469) 398-2781
mkaliser@kaliserlaw.com
Cindy Mirliss (469)398-2782
cmirliss@kaliserlaw.com
Greg Ehrlich (469)398-2783
gehrlich@kaliserlaw.com
Megan Oh, Paralegal
(469) 398-2784
moh@kaliserlaw.com
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