When will a general solicitation ruin your ability to rely on Rule 506(b)?
Section 4(a)(2) of Rule 506(b) provides a “safe harbor” for companies that comply with certain requirements. In addition to a prohibition from using general solicitation to market securities, the requirements of the exemption include:
- A company may sell its securities to an unlimited number of “accredited investors” and up to thirty-five other purchasers
- A company’s information provided to accredited investors must not violate antifraud provisions of federal securities laws, and must not contain false or misleading statements
- Companies must make themselves available to prospective purchasers to answer questions
Rule 506 does not limit how many people the issuer may offer securities. However, offers to a significant number of people may be considered a general solicitation resulting in the loss of the private placement exemption.
Once you have lost your exemption then you must file a registration statement in order to register the securities. Alternatively, you must halt fundraising for six months before you can start a new offering of the same type.
For example, sending an email to every person in your contacts list stating that you are planning to raise money soon might qualify as general solicitation if the message was sent to enough people to be considered public and the email’s text was related to the offering.
According to an analysis conducted by Kilpatrick Townsend & Stockton LLP of a recent SEC disciplinary action opinion, the SEC has a “zero-tolerance” policy regarding general solicitations. (See: https://www.lexology.com/library/detail.aspx?g=ca800c6d-58dd-42dc-99c8-d3092f9e75490 ) According to the facts of the disciplinary action, an issuer went ahead and accepted funding from accredited investors they had a pre-existing relationship with after they were informed that their prior newspaper advertisement was general solicitation. The issuer thought they could continue with the offering because they had complied with all other requirements of the Rule 506(b) safe harbor. However, in the disciplinary action opinion, the SEC explicitly stated that regardless of whether the other terms with complied with, the company lost its ability to rely on 506(b) as soon as they generally solicited.
Making sure you are in full compliance with all SEC regulations and procedures is the primary focus of the law firm of Wilson, Bradshaw & Cao, LLP. Your success in going public and staying in good standing with the SEC will bring lasting benefits to your company.