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» SEC ISSUES FINAL AMENDMENTS TO RULE 506

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For many companies, looking for investments to grow their businesses, there was a sense that this day would never come. The Securities Exchange Commission (“SEC”) concluded its process today and issued a final ruling eliminating the prohibitions on general solicitations, advertising Regulation D offerings to the general public.

The final SEC changes to rule 506 have two major changes which impact the industry, the first more so than the second.

Provision number one is in accordance with the Jumpstart Our Business Startups Act (“JOBS Act”) which effectively eliminates the ban on advertising of private offerings claiming a registration exemption under Regulation D. There are provisions, however.  The most serious provision is that the purchasers of securities are still required to be accredited investors.

The second rule change is in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) which amends Rules 501 and 506 to prohibit felons and other “bad actors” from participating in Regulation D offerings.

Our main focus for today is on the first rule, allowing general solicitation.

The SEC effectively punted on giving a detailed description of what “General Solicitation” and “General Advertising” entails, instead giving a broader description that describes these activities as such “published in newspapers and magazines, communications broadcast over television and radio, and seminars where attendees have been invited by general solicitation or general advertising.”  Further, the SEC has “confirmed that other uses of publicly available media, such as unrestricted Web sites, also constitute general solicitation and general advertising.”

Additionally, in passing the final ruling, section(C) was added to Rule 506 in order to list out the particular conditions under which a general solicitation, for a securities offering exempt under regulation D, may occur. This new section requires the issuer to take reasonable steps to verify whether or not an investor is accredited. It provides a list of both non-exclusive and non-exhaustive factors to be considered by a company when reviewing the accreditation status of an investor. These are the SECs encouraged methods of verification to reach a standard of “reasonableness” are:

  • Reviewing the tax records of the individual for the two most recent years and obtaining written representation that the individual believes that they will reach the necessary income levels to qualify in the current year.
  • Reviewing third-party documentation from the prior three months such as bank and brokerage statements, tax assessments, appraisal reports, and credit reports that identify the potential purchaser’s net worth, including assets and liabilities, together with a written representation from the individual that all liabilities necessary to make a determination of net worth have been disclosed.
  • Obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such individual has taken reasonable steps to verify that the potential purchaser is an accredited investor within the prior three months and has determined that the potential purchaser is an accredited investor; and
  • Regarding an existing investor who qualified as an accredited investor prior to the effective date of the new rule 506(c), obtaining a certification by the investor at the time of sale that he or she qualifies as an accredited investor.

The SEC has made it clear in the ruling that it does not consider the checking of a box on a questionnaire or a signed form, in the absence of other information, to be sufficient diligence in meeting the “reasonable” threshold. It is extremely important for companies and investment representatives to understand that by lifting the advertising ban on Rule 506 the SEC has effectively placed additional controls on the process.  While general solicitation does open the door to acquiring additional investors, it is coming with a price.

 

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