Table of Contents
Complying with Regulation D 506 (c)
The Jumpstart Our Business Startups Act or JOBS Act of April 2012 was intended to encourage funding of United States small businesses by easing various securities regulations. It passed with bipartisan support. The law provides that general solicitation does not make the offering a “public offering” under federal law. The SEC did not adopt the rule providing exceptions to the General Solicitation for Regulation D 506 (c) until July of 2013. It overturned 80 years of regulatory restriction. There are more opportunities for small business funding in the United States than ever before.
General Solicitation in Unregistered Offerings
General solicitation is allowed if all purchasers are “accredited investors” as defined in Reg D 501, and reasonable steps are taken to verify the accreditation of the investors. In addition, the Form D must be filed at least 15 days before any general solicitation.
Regulation D 506 (c) offerings are “covered securities” and state law registration requirements are preempted. States may (and usually do) require filings and the payment of a fee but cannot prohibit the general solicitation of investors in their states.
The “catch” is the requirement of proof of accreditation status within 3 months of the sale of the security.
The “disqualifying events” under Rule 506(d) are:
- Criminal convictions in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities) within ten years before the sale of securities (or five years, in the case of issuers, their predecessors and affiliated issuers);
- Court orders, judgments or decrees (in connection with the purchase or sale of any security; involving the making of any false filing with the SEC; or arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser or paid solicitor of purchasers of securities) entered within five years before the sale, that, at the time of the sale, restrains or enjoins such person from engaging or continuing to engage in such conduct or practice;
- Final orders of certain state regulators (such as state securities, banking and insurance regulators) and federal regulators, including the CFTC, (if the order is based on fraudulent, manipulative or deceptive conduct, there is a ten year look-back; if the order bars a covered person from engaging in specified activities, the order would be disqualifying for as long as the bar was in effect);
- SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers and investment companies and their associated persons for so long as such orders are in effect;
- SEC cease-and-desist orders relating to violations of certain anti-fraud provisions and registration requirements of the federal securities laws entered within five years before such sale;
- Suspension or expulsion from membership in, or suspension or bar from associating with a member of, a securities self-regulatory organization for the duration of the suspension or expulsion;
- SEC stop orders and orders suspending a Regulation A exemption issued within five years before such sale; and
- U.S. Postal Service false representation orders entered within five years before such sale.
Disqualification of Bad Actors
Rule 506 (d) identifies the disqualified bad actors (“covered persons”) in the following categories:
- The issuer and any predecessor of the issuer or affiliated issuer;
- Any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer;
- any beneficial owner of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
- Any investment manager to an issuer that is a pooled investment fund and any director, executive officer, other officer participating in the offering, general partner or managing member of any such investment manager, as well as any director, executive officer or officer participating in the offering of any such general partner or managing member;
- Any “promoter” connected with the issuer in any capacity at the time of the sale;
- Any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with sales of securities in the offering (referred to as a “compensated solicitor”); and
- Any director, executive officer, other officer participating in the offering, general partner, or managing member of any such compensated solicitor.
The determination of which officers participated in an offering is a question of fact but it is more than transitory or incidental involvement It could include activities such as participation or involvement in due diligence activities, involvement in the preparation of disclosure documents, and communication with the issuer, prospective investors or other offering participants.
Reasonable Care Exemption
An issuer will not lose the Rule 506 safe harbor, despite the existence of a disqualifying event, if the issuer can show that it did not know and, in the exercise of “reasonable care,” could not have known of the disqualification. For continuous, delayed or long-lived offerings (such as those conducted by hedge funds and private equity funds), reasonable care includes updating the factual inquiry on a reasonable basis. The frequency and degree of updating will depend on the circumstances of the issuer, the offering and the participants involved, but in the absence of facts indicating that closer monitoring would be required (i.e., notice that a covered person is the subject of a judicial or regulatory proceeding), the SEC expects that periodic updating could be sufficient which could be through contractual covenants from covered persons to provide bring-down of representations, questionnaires and certifications, negative consent letters, periodic rechecking of public databases, and other steps, depending on the circumstances.
Waiver of Disqualification
The SEC’s Director of the Division of Corporation Finance may grant a waiver if he or she determines that the issuer has shown good cause that it is not necessary under the circumstances that the registration exemption be denied.
Disqualification will not arise if a state court or regulatory authority enters an order, judgment or decree; and advises in writing that disqualification under Rule 506 should not result.