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.