Rule 506 Gets a Huge Lift from the JOBS Act

By John Myer | Published: April 29, 2012

Rule 506 of Regulation D is a safe harbor for the private offering exemption of Section 4(2) of the Securities Act.  The Rule allows issuers to raise an unlimited amount from accredited investors. Rule 502(b)(1) prescribes no specific form of disclosure in a Rule 506 offering solely to accredited investors.  That means it may be sufficient for a common stock offering if the CEO prepares a detailed slide deck and the attorney prepares a shareholders’ agreement, a subscription agreement (including detailed risk factors) and files a Form D with the SEC and the relevant states.  Of course, convertible notes and preferred stock require a bit more work, but that is not an insurmountable barrier. State regulatory involvement beyond fees and notice filings are pre-empted in an offering by an issuer under Rule 506.

But how does a start-up company find investors?  Up to now, that was the real barrier. In essence, a start-up could raise money from people it already knew, but could not advertise that it was looking for investors.  But Section 201 of the JOBS Act changes the playing field fundamentally.  The SEC has been instructed by Congress to modify Rule 506 by July 4, 2012 so that the prohibition against general solicitation and advertising found in Rule 502(c) will not apply to transactions under Rule 506 if all investors are accredited. The SEC is also charged with promulgating rules that will require issuers to verify whether potential investors are indeed accredited, but the SEC Staff can take their time on that.

Section 201 of the JOBS Act also amends Section 4 of the Securities Act to exempt from broker/dealer registration persons who maintain public platforms that facilitate Rule 506 transactions. These facilitators may co-invest and provide due-diligence services and document templates.  However, these facilitators may not receive brokerage fees, provide custody services, give investment advice, or negotiate the terms of a deal.

While Crowdfunding may be a dud (please see: Complying with the Crowdfund Act Won’t Be Trivial), Rule 506 is now more than ever the king of private placement exemptions.

I invite your comments to this blog post and look forward to posting another missive in the near future.

John A. Myer is a corporate and securities lawyer with Myer Law PLLC in Seattle, Washington.   This posting does not constitute legal advice.

 

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  • http://www.Empower.me/ Bryan Starbuck

    Great blog post John.  I hope you keep them coming.  I’d highly recommend getting it submited to Hacker News, since that is the biggest websites for startup founders.  :-)

    • http://www.myercorplaw.com/ John A. Myer

       Thanks, Bryan!  I sent them a link and let’s see if they like it as much as you did.

  • CLeyerle

    Given how far the SEC is behind on rules for Dodd Frank I doubt they will have JOBS Act rules done in the 90 day window.

    Rule 506 is the best, for sure, but disclosure rules are actually tighter under the JOBS Act, including audited financials for raises over $500K.I worry about who will vet investor representations of accreditation, and what safe harbors will exist for companies raising money from strangers.

    The Act makes things harder, not easier for entrepreneurs. All the real benefits are for investors.

    • http://www.myercorplaw.com/ John A. Myer

      I’m sure the SEC will not make the timetables requested by Congress, so thanks for raising that point.  The disclosure rules you refer to do not effect 506 deals, though. The ability to advertise and solicit will make things significantly easier for issuers, so I don’t agree with your general observation.

      • CLeyerle

        My mistake; the new rules on financial disclosure apply to crowdfunding raises only, which I presume are not Rule 506. (Are they covered under any of the other rules, or is this a wholly new exemption outside of Rules 504-506?)

        There is still a question in my mind, however, about how an issuer ensures all the investors are accredited. If one accepts a subscription from an investor who inaccurately claims to be accredited, does that cause the loss of the exemption?

        • http://www.myercorplaw.com/ John A. Myer

          Crowdfunding is Section 4(6) of the Securities Act.  Rule 506 is a safe-harbor under Section 4(2) of the Securities Act.  The two have no law in common, but they have many of the same features nonetheless.

          Under Rule 506, a reasonable believe that an investor is accredited in sufficient.  That is why for the past 35 years, if someone told you in writing that they were accredited, that was all that was required.  But the JOBS Act has a provision requiring the SEC Staff to come up with rules on verification that may change all that.  We will have to wait and see.