29. What is a “Rule 506” exemption?
Rule 506 of Regulation D allows for two exemptions of securities issuances. The statutory authority for a Rule 506 is pursuant to Section 4(a)(2) of the ’33 Act. Rule 506 exemptions are the most commonly employed exemptions to securities registration.
Rule 506(c) – Exemption Pursuant to JOBs Act of 2013
The JumpStart our Businesses Act of 2013 (JOBs Act) made extensive changes to the securities registration exemption regime. As a result, it allowed the SEC to develop Rule 506(c) exemption with the following characteristics:
• Issuer Protections – Rule 506(c) applies to issuers to the same extent as Rule 506(b).
• Dollar Limits – The exemption allows an issuer to raise an unlimited amount of funds.
• Purchaser Requirements – The most daunting requirement of Rule 506(c) offerings is the requirement that the issuer verify that each purchaser of securities is accredited. An issuer who fails to exercise reasonable care in making this determination risks losing the exemption. The standard for judging an issuer’s reasonable efforts to make this determination is uncertain. The SEC identified four primary methods of verifying that an individual is an accredited investor, including:
⁃ Annual Income – The issuer may examine proof of the purchaser’s income, such as IRS filings from the last two tax years.
⁃ Note: This may require a certification by the issuer that they expect to sustain the previous years’ earnings.
⁃ Net Worth – The issuer may examine bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessment, or appraisal reports, and consumer reports from a national agency, or obtain a written representation that purchaser has disclosed all liabilities.
⁃ Professional Certification – The issuer may receive a written representation from a registered broker-dealer or investment advisor, licensed attorney, or CPA that such person has taken reasonable steps to verify that the purchaser is an accredited investor as of the last three months.
⁃ Written Verification – If the prospective purchaser is a previously verified accredited purchaser, a written verification that such person is still accredited.
• Restricted Securities – The shares received by the investor under the exemption are “restricted”.
• General Solicitation – The rule allows for general solicitation in an issuance where all purchasers are accredited investors and the issuer takes reasonable care to determine that each investor is accredited.
• Private Placement Memorandum – Before consummating a sale, the issuer must provide the purchaser with adequate disclosures under Regulation D.
• State Regulation – Rule 506(c) are covered securities that are exempt from state regulation.
• Discussion: Why do you think Congress felt the need to provides for a specific exemption to accredited investors that also allows for general solicitation? Do you feel that the ability to generally solicit purchasers of securities undermines the purpose of public disclosure? Why or why not?
• Practice Question: ABC Corp is a wildly successful startup company that is growing by 300% per year. ABC needs about $100 million in investment capital reach its growth goals for the next 18 months. In a brief letter, can you summarize the benefits and drawbacks of seeking an exemption from securities registration under Rule 506? Specifically focus on the differences between rules 506(b) & 506(c).