Regulation D 506(c) General Advertising and Solicitation Exemption – Issuer Execution Toolkit and Protocols

Clients executing a Regulation D 506(c) (General Advertising) Offering will be subject to a different set of rules and execution protocols than a normal private placement offering.  We have developed this page to serve as an Issuer “506(c) Toolkit” providing our clients with information on required advertising and promotion legend language, investor verification information, Federal filing differences, “Bad Actor” rules, and other 506(c) related issues.

Federal Filing Submission

Do not engage in ANY general advertising of the offering or general solicitation of investors until the Form D filing has been submitted and received by the SEC.

Advertising Legend Language (IMPORTANT!):

Any advertising or promotion of the offering must be accompanied by certain legend language (or a verbal reading of the language (radio ad for example) that provides some basic risk disclosure to potential investors.  We suggest using this legend in ALL communication regarding the offering (emails, written letters, etc) and any and all open mention of the offering (website mentions, blog posts, press releases, etc.).  Our recommended minimum 506(c) legend language is as follows:

Securities and Exchange Commission Regulation D 506(c) Mandated Legend – Use the Text Below:

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These securities are being offered under an exemption provided by SEC Regulation D Rule 506(c).  Only accredited investors who meet the SEC Regulation D 501 “accredited investor” accreditation standards and who provide suitable verification of accredited status may invest into this Offering.

  • Any historical performance data represents past performance.  Past performance does not guarantee future results;
  • Current performance may be different than the performance data presented;
  • The Company is not required by law to follow any standard methodology when calculating and representing performance data;
  • The performance of the Company may not be directly comparable to the performance of other private or registered funds or companies;
  •  The securities are being offered in reliance on an exemption from the registration requirements, and therefore are not required to comply with certain specific disclosure requirements;
  • The Securities and Exchange Commission has not passed upon the merits of or approved the securities, the terms of the offering, or the accuracy of the materials.

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Regulation D Rule 506(c) Investor Verification Standards and Protocols

In purchasing securities through a 506(c) Offering, the Company is obligated to verify any participating investor’s status as an accredited investor in accordance with Rule 501 of Regulation D.  There are three primary methods the Company may employ to comply with the verification standards.  Note – most issuers use third party verification (broker-dealer letter, attorney letter, CPA letter, or a third party speciality services like verifyinvestor.com) to obtain proper and suitable verification.  It is possible for the investor to provide bank statements and/or IRS tax forms – however most clients do not want the responsibility of reviewing those types of records and forms.

Investors in the offering will need to provide the Company with verification that meets the standards and form using one or multiple methods as listed below:

(1) Income:  The Company may verify an individual’s status as an accredited investor on the basis of income by reviewing copies of any IRS form that reports net income, such as Forms W-2 or 1099 (which are typically filed by an employer or other third party payor), or Forms 1040 filed by the prospective purchaser (with non-relevant information permitted to be redacted). Under this method, the Company must review IRS forms for the two most recent years and obtain a written representation from the prospective purchaser that he or she has a reasonable expectation of attaining the necessary income level for the current year. Where accredited investor status is based on joint income with the person’s spouse, the IRS forms and representation must be provided with respect to both the purchaser and the spouse.

(2) Net Worth: Under this method, the Company will need to review bank or brokerage statements or third-party appraisal reports to verify the purchaser’s assets and a credit report to verify liabilities, in each case dated within the prior three months, and will need to obtain a written representation from the prospective purchaser that all liabilities have been disclosed. Where accredited investor status is based on joint net worth with the person’s spouse, the asset and liability documentation and representation must be provided with respect to both the purchaser and the spouse.

(3) Reliance on Determination by Specified Third Parties to Provide Verification: The Company may satisfy the verification requirement if it obtains a written confirmation from a registered broker-dealer (who the investor has had an account with longer than 6 months), an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that within the prior three months such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor and has determined that the purchaser is an accredited investor.  Third party services, such as Verifyinvestor.com (managed by an attorney) are also qualified third party providers of verifications.

Proper verification must be submitted with the subscription for securities in order for the Company to verify the investor’s suitability for investment and accept the subscription.  The Company should maintain accurate records of this verification.  During the offering term, any verifications beyond 3 months old will need to be re-verified and re-submitted to maintain compliance.  Once the offering is closed, this update requirement is null.

Bad Actor Amendments to Rule 506

The “bad boy” provisions have been added as a new paragraph (d) to Rule 506. These provisions disqualify an offering from utilizing the Rule 506 exemption from registration if certain persons related to the issuer or the offering have engaged in specified “bad acts.” The disqualification provisions apply to offerings under Rule 506(b) and Rule 506(c). Covered Persons. The disqualification provisions apply to the following categories of persons (“covered persons”):

  • The issuer, any predecessor of the issuer, and any affiliated issuer.
  • Directors of the issuer.
  • Executive officers of the issuer, as well as other officers of the issuer who participate in the offering. The release indicates that “participation” in the offering refers to more than incidental involvement, and could include involvement in due diligence, preparation of disclosure documents, and communications with prospective investors or other participants in the offering process.
  • General partners and managing members 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.
  • Promoters connected with the issuer in any capacity at the time of the sale. (The term “promoter” is defined in Rule 405 to mean anyone who, alone or together with others, directly or indirectly takes initiative in founding the business, or who in connection with the founding of the business receives 10% or more of a class of issuer securities or 10% or more of the proceeds from the sale of a class of issuer securities.)
  • Any person being paid (directly or indirectly) for soliciting purchasers in the offering (as well as such person’s general partners and managing members, and the directors, executive officers, other officers participating in the offering, general partners, and managing members of the solicitor or its general partner or managing member).
  • Investment managers of issuers that are pooled investment funds (as well as such investment manager’s general partners and managing members, and the directors, executive officers, other officers participating in the offering, general partners, and managing members of such investment manager or its general partner or managing member).

Disqualifying Events. Rule 506 is unavailable if any covered person has engaged in any of the following disqualifying events, unless either the SEC or the court or regulatory body that issued the relevant order determines that disqualification is not necessary in the particular circumstances and grants a waiver of disqualification. In addition, even if there is a disqualifying event, an offering will not lose the Rule 506 exemption if the issuer can establish that it did not know, and in the exercise of reasonable care based on factual inquiry could not have known, that a disqualification existed.

  • Criminal Convictions. An offering is disqualified if any covered person was convicted of a misdemeanor or felony (i) in connection with the purchase or sale of a security, (ii) involving the making of a false filing with the SEC, or (iii) 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. A conviction is disqualifying only if it occurred within five years before the Rule 506 sale in the case of the issuer, its predecessor, or an affiliated issuer, and ten years before the Rule 506 sale in the case of all other covered persons.
  • Court Injunctions and Restraining Orders. An offering is disqualified if any covered person is subject to a court order entered into within five years before the Rule 506 sale that restrains such person from engaging in any conduct or practice (i) in connection with the purchase or sale of a security, (ii) involving the making of a false filing with the SEC, or (iii) 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. A court order is not a disqualifying event if either it was entered into more than five years before the offering (even if it remains in effect at the time of the offering) or if the court order is no longer in effect at the time of the offering (even if entered into within the five-year period).
  • Final Orders of Regulators. An offering is disqualified if any covered person is subject to a final order (including a settlement order) of a state securities regulator, federal or state banking regulator, state insurance regulator, or the CFTC that (i) at the time of the Rule 506 sale bars the person from associating with an entity regulated by such regulator; engaging in the business of securities, insurance, or banking; or engaging in savings association or credit union activities; or (ii) is based on a violation of a law or regulation that prohibits fraudulent, manipulative or deceptive conduct and was entered into within ten years before the Rule 506 sale. Bars are disqualifying for as long as they are in effect, regardless of how long ago they were ordered. By contrast, final orders covered in clause (ii) cease to be disqualifying ten years after their entry.
  • SEC Disciplinary Orders. An offering is disqualified if any covered person is subject to an SEC order under specified provisions of the securities laws that, at the time of the Rule 506 sale, (i) suspends or revokes such person’s registration as a broker, dealer, municipal securities dealer, or investment adviser; (ii) places limitations on the activities, functions, or operations of such person; or (iii) bars such person from being associated with any entity or from participating in an offering of penny stock. Disqualification continues for as long as some act is prohibited or required to be performed pursuant to the order. As a result, there is no cut-off date if the order involves a permanent prohibition. However, if the order calls for performing a specific act (such as paying a penalty), the order is no longer disqualifying once the required act has been fully performed.
  • SEC Cease-and-Desist Orders. An offering is disqualified if any covered person is subject to an SEC order entered into within five years before the Rule 506 sale that orders the person to cease and desist from committing or causing violations or future violations of (i) any scienter-based anti-fraud provision of the federal securities laws, or (ii) Section 5 of the Securities Act.
  • Suspension or Expulsion from SRO Membership or Association with an SRO Member. An offering is disqualified if any covered person is suspended or expelled from membership in, or suspended or barred from association with, a stock exchange or other self-regulatory organization for conduct inconsistent with just and equitable principles of trade.
  • SEC Stop Orders. An offering is disqualified if any covered person was an issuer or underwriter of an offering which, within five years of the Rule 506 sale, was subject to an SEC stop order or order suspending Regulation A exemption, or is, at the time of the sale, the subject of an investigation or proceeding to determine whether such an order should be issued.

US Postal Service False Representation Orders. An offering is disqualified if any covered person is subject to a US Postal Service false representation order entered into within five years before the Rule 506 sale, or is, at the time of the sale, subject to an injunction or temporary restraining order with respect to conduct alleged to constitute a scheme for obtaining money or property through the mail by means of false representation.

More information can be sourced here:

http://www.sec.gov/info/smallbus/secg/bad-actor-small-entity-compliance-guide.htm

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