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Overview of Rule 506(c) and 506(b) Offerings

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What are the real differences between Rule 506(c) and 506(b) Offerings?
The chart below covers a few of the differences between 506(b) and 506(c) offerings. Please note that this is not legal advice. You should consult with your own attorney before conducting a 506(b) or 506(c) offering. Securities regulations (and interpretations regarding such regulations) are subject to change.

 

506(b) Offering 506(c) Offering
Communications with Investors Companies may not advertise their security offering. Generally, companies may approach potential investors if there is a substantive, pre-existing relationship. General advertising permitted. Companies may advertise via social media, email, or offline. No substantive, pre-existing relationship with potential investors required.
Eligible investors Accredited investors and up to 35 non-accredited investors who meet sophistication requirements. Only accredited investors.
Accreditation Process Self-certification via a questionnaire is the general standard.

 Companies must take reasonable steps to verify accredited investor status. Self-certification via a questionnaire is not permissible. The SEC issued examples of reasonable steps for verification.
Offering size No limit on offering size. No limit on offering size.
Disclosure Companies must decide on what information to provide to accredited investors, but that information must not violate antifraud prohibitions. If non-accredited investors are included, companies must provide those investors with disclosure documents that are generally the same as those used in registered offerings. If a company provides information to accredited investors, it must make that information available to non-accredited investors as well. Companies must be available to answer questions from potential investors. Companies must decide on what information to provide to accredited investors, but that information must not violate antifraud prohibitions. Companies must be available to answer questions from potential investors.
Filing Requirements Companies must file a Form D. Companies must file a Form D.
Intermediaries Not required. If used, the intermediary must be a registered broker-dealer or exempt from broker-dealer registration. Not required. If used, the intermediary must be a registered broker-dealer or exempt from broker-dealer registration.

RULE 506(C)

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RULE 506(C): WHAT CAN I SHOW ON MY SITE, TO WHOM, AND WHEN?

The SEC no-action letters issued to FundersClub and AngelList early in 2013 created some confusion around the deal-specific information that can be shown to prospective investors. Let’s try to clear that up.

Rule 506(b) Deals

You cannot show your Rule 506(b) deals to just anyone browsing the Internet, because that would be “general solicitation and advertising,” which is permitted under Rule 506(c) but still prohibited under Rule 506(b). If you’re a real estate portal, you can say “We have great real estate deals on our site,” but you can’t say “Look at this multi-family rental project in Austin.”

Both FundersClub and AngelList hid their deals behind a firewall. A user couldn’t see the deals until he registered at the site and promised he was accredited. In the 2013 no-action letters the SEC approved this arrangement, sort of.

I say “sort of” for three reasons:

The two no-action letters weren’t actually about registering users. They were about whether FundersClub and AngelList had to register as broker-dealers. Nowhere do the no-action letters say “We agree that, because you hide your deals behind firewalls, you’re not engaged in prohibited general solicitation and advertising.”
The no-action letters were issued by the Division of Trading and Markets within the SEC, not the Division of Corporation Finance. Typically, the Division of Corporation Finance would deal with so-called “exempt offerings” (offerings that are exempt from the general registration requirements of the Securities Act of 1933), of which general solicitation is a part.
Most intriguingly, the no-action letters aren’t exactly consistent with prior SEC rulings dealing with the online solicitation of customers, specifically the IPONET rulings in 2000. Those rulings assumed that the person doing the online solicitation was a registered broker-dealer; by definition, FundersClub and AngelList were not broker-dealers.
As a result, we can’t be 100% certain that the SEC, if asked point blank, would approve those arrangements from the perspective of general solicitation and advertising.

Nevertheless, the no-action letters were issued and the Crowdfunding industry has adopted the FundersClub and AngelList model: if you’re doing Rule 506(b) deals, you put the actual deals behind a registration firewall.

Once an investor registers at your site he can see the deals, but he can’t invest in them. In a series of no-action letters issued long before the JOBS Act, the SEC established that once an investor has become a customer, he has to wait before investing – the so-called “cooling off period.”

Some sites today are using a 21 day cooling off period, presumably because Title III incorporates a 21 day cooling off period. But the Title III rule is irrelevant to Rule 506(b). Thirty days is probably better, although, again, the notion of a cooling off period comes from SEC rulings, not a statute.

One more twist: at the end of the cooling off period, your investor can invest only in new deals, not deals that were on the site when he registered.

Rule 506(c) Deals

Rule 506(c) is far simpler. If you are doing only Rule 506(c) deals, you can show anything to anyone anytime.

Using Rule 506(c), you can show every detail of every deal to every casual viewer, even before the viewer has registered at your site. If you think that’s a bad idea from a marketing perspective or because you’re trying to protect confidential information, no problem. You don’t have to show all the details on your home page, but you can.

You can also make users register before they can see deals, just like Rule 506(b). If you take that route, you can ask users whether they’re accredited when they register, as you would under Rule 506(b), but you don’t have to ask. You can let everyone see the deals, accredited and non-accredited alike.

If you ask whether users are accredited – because you think it’s a good idea from a marketing perspective – that doesn’t mean you have to stop non-accredited investors at the door. Non-accredited investors can see the deals, too. Maybe they’ll tell their accredited friends.

Suppose a user tells you she’s accredited when she registers. Can you take her word for it? At that point in the process, absolutely! We don’t want to spend money or time on verification yet, and we don’t want to create transactional friction where we don’t have to.

With Rule 506(c), there is only one critical moment: when your investor is ready to write a check. At that point you must verify that she’s accredited, not merely by asking her but by looking at her tax returns, or getting a letter from her lawyer, or, most likely, having her verified by a third party service like VerifyInvestors or Crowdentials.

There’s no cooling off period with Rule 506(c), either. Your investors can see all the deals and invest right away.

Have I mentioned before that Rule 506(c) is better for Crowdfunding?

FinLaw: Who will buy your company’s stock?

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By Scott Andersen, Reprinted from CrowdFundBeat

There is a maxim used by securities professionals that “stocks are sold, not bought.” This maxim summarizes the view that for a securities offering to be successful, it needs a broker-dealer to solicit and recommend the offering to prospective investors.

Now with the JOBS Act and companies selling securities directly to investors through general solicitation (advertising), the question is raised: who will buy your company’s stock? Moving away from a broker-dealer to reliance on advertising alone requires careful planning for an offering to be successful. This is difficult for a company that has not raised capital before. For one, there may be no securities professionals involved in structuring the offering, or marketing or selling it. Other professionals, such as attorneys, may recommend a Reg A offering but are not retained to provide guidance on how to market a successful offering. Failure means a blow to a company’s reputation and coffers; simply wasted money.

To raise capital under Rule 506(c) or Reg A, a company must plan carefully its marketing campaign, including how it will attract interest in its securities offering, how it will draw visitors to its website hosting the offering, and why it is likely that an investor will press the “invest now” button and invest? The company is driving the ship here, and must take responsibility for the offering to be successful. If the company lacks the experience or confidence to do so, it should hire a broker-dealer to solicit the offering as this will increase its odds of success. Broker-dealers have existing relationships with investors whom they can solicit and can provide advice on the terms of the offering. A company initiating a marketing campaign needs to find ways to introduce itself to the public and network to and develop relationships with prospective investors. The marketing should not be limited to creating a website and video and then expecting investors to come find the company as this alone generally will not work.

A few things to consider:

While a company may view its securities offering as great and a no brainer, others including prospective investors may not necessarily see it the same way. A company needs to market the offering, and in a manner compliant with securities laws.

Who is the targeted audience? Customers of a company and true believers are an ideal target audience. If not them, who? And what is the marketing strategy for reaching them?

Is a Reg A the right type of securities offering? Maybe a Reg D or Title III make more sense initially, especially if this is the first time a company is raising capital. In this way, a company pays lower legal fees while having an opportunity to test its online marketing strategy, the offering is ready to launch faster, and with Title III, a company can tap into a funding portal’s network of investors.

The minimum offering should both help a company take the next step in growing its business and be low enough that it is realistic for the company to successfully raise this amount.

A securities offering is not a race, and speed is a lot less important than success. Careful planning of a company’s marketing strategy is essential, and the company should obtain the help it needs to be effective, persuasive and compliant.

The key goal for any securities offering is to be successful. Without a proper marketing strategy, how can any company expect to attract visitors to a website to invest? Without a proper marketing strategy, the answer to the question of who will buy your company’s stock is clear: possibly no one.

***

About: Scott Andersen
Scott is principal at finLawyer.com and General Counsel of FundAmerica. He was most recently the Deputy Regional Chief Counsel at FINRA, and prior to that was the Enforcement Director at FINRA and the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of NY. He concentrates his practice on securities law and regulatory defense.

The information in this article is provided for general informational purposes only and is not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.

Improving Legal Documents in Crowdfunding: Get Rid of the State Legends!

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By Mark Roderick, crowdfunding attorney with Flaster/Greenberg PC.

I see lots of offering documents like this, with pages of state “legends.” The good news is that in Crowdfunding offerings – Title II (Rule 506(c)), Title III (Regulation Crowdfunding), and Title IV (Regulation A) – you can and should get rid of them.

The legal case is pretty simple:

Before 1996, states were allowed to regulate private offerings. Every state allowed exemptions, but these exemptions often required legends, differing from state to state. The National Securities Market Improvement Act of 1996 added section 18 to the Securities Act of 1933. Section 18 provides that no state shall “impose any conditions upon the use of. . . .any offering document that is prepared by or on behalf of the issuer. . . .” in connection with the sale of “covered securities.” The securities sold under Title II, Title III, and Title IV are all “covered securities.” Hence, section 18 prohibits states from imposing any conditions regarding the issuer’s offering documents, including a condition that requires the use of a state legend.

If the capitalized legends just take up space, why not include them anyway just to be safe? Take Pennsylvania’s legend as an example:

These securities have not been registered under the Pennsylvania Securities Act of 1972 in reliance upon an exemption therefrom. any sale made pursuant to such exemption is voidable by a Pennsylvania purchaser within two business days from the date of receipt by the issuer of his or her written binding contract of purchase or, in the case of a transaction in which there is not a written binding contract of purchase, within two business days after he or she makes the initial payment for the shares being offered.

If you include the Pennsylvania legend “just to be safe,” you’ve given Pennsylvania investors a right of rescission they wouldn’t have had otherwise!

Two qualifications.

First, the North American Securities Administrators Association –the trade group of state securities regulators – suggests including uniform legend on offering documents. I include this or something similar as a matter of course:

IN MAKING AN INVESTMENT DECISION INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THESE SECURITIES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL OR STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THESE SECURITIES ARE SUBJECT TO RESTRICTIONS ON TRANSFERABILITY AND RESALE AND MAY NOT BE TRANSFERRED OR RESOLD EXCEPT AS PERMITTED UNDER THE ACT, AND THE APPLICABLE STATE SECURITIES LAWS, PURSUANT TO REGISTRATION OR EXEMPTION THEREFROM. INVESTORS SHOULD BE AWARE THAT THEY WILL BE REQUIRED TO BEAR THE FINANCIAL RISKS OF THIS INVESTMENT FOR AN INDEFINITE PERIOD OF TIME.

Second, some states, including Florida, require a legend to appear on the face of the offering document to avoid broker-dealer registration. Because Section 18 of the Securities Act doesn’t prohibit states from regulating broker-dealers, some lawyers recommend including those legends, while others believe those requirements are an improper “back door” way for states to avoid the Federal rule. I come out in the latter camp, but opinions differ.

Markley S. Roderick concentrates his practice on the representation of entrepreneurs and their businesses. He represents companies across a wide range of industries, including technology, real estate, and healthcare.