REGULATION D, RULE 506 (C)

In the U.S., the Securities and Exchange Commission (SEC) under Regulation D refers to an accredited investor as a registered broker, investment advisor, business entity or a person who financially knowledgeable and enjoys reduced requirements by the regulatory disclosure filings. The accredited investors include HNWI (high net worth individuals), banks, trusts, insurance companies and brokerages.

For an individual to be an accredited investor, they must report an annual income exceeding $200,000 ($300,000 for joint income) for the previous two years with a projected earning of the same or a higher income in the current year. The threshold for the last two years must reflect the income of an individual either alone or with a spouse. This requirement cannot be met in the income test by the discrepancy of showing one year for an individual income and subsequent two years of a joint income with a spouse. 

A person can also be considered an accredited investor if they have a net worth exceeding $1 million individually or with a spouse. The other conditions by the SEC for individual’s accreditation is if they a director, executive officer or general partner for the business entity which is issuing the unregistered securities.

For an entity, the conditions for being accredited if it is a private business development company or an organization whose assets exceed $5 million. However, if an entity has owners who are accredited investors, the entity qualifies to be an accredited investor, but an organization cannot be formed solely for the purchasing some securities. 

REGULATION D, RULE 506 (C) 

Security and Exchange Commission (SEC) established Regulation D in the 1980’s for the purpose of outlining a way of offering Securities privately. Over the last couple of years, the commission has undergone several changes as a result of the 2012 Jumpstart Our Business Startups Act. This act commonly known as the JOBS Act, was meant to help smaller companies in accessing capital formation by removing the barriers. They would do this by easily attracting investors through the introduction of Rule 506 (c) and by the regulation of the equity crowd-funding. 

Under Reg. D, companies can sell preferred equity without being registered with the SEC. There are varied exemptions used by companies to offer investments to the general public such as Rule 506 (c). The only conditions to this are: 

  • The investors who are allowed to make an investment must be accredited. However, they do not have a limit to the investment.
  • The company verifies the accreditation of the investors by reviewing their documentation like W-2s, brokerage and bank statements, tax returns, credit reports and others.

However, the investors do not have a limit to the investment.

Every capital raise does not necessitate a PPM. While Reg. D Rule 506 works with the antifraud provision of the laws of the federal security to dictate that accurate and honest information must be availed by the issuers to the accredited investors, there is no condition that this information has to necessarily be specific in nature.

SEC Rule 506 (c) could be the most popular Private Placement Reg. because it allowed general solicitations of Private Placements to Accredited Investors for the following reasons:

  • Rule 506 (c) of Reg. D which was approved by the SEC on July, 2013 enabled advertising for Reg. D Offerings. Accredited investors are allowed to purchase the Securities offered. The Offering documents must be presented to SEC within 15 days for the solicitation to ensue, and a notification also within 15 days when the investor makes the first purchase. Failure to comply with the timelines of the filing could result in a ban of the Issuers access to Reg. D market for 1 year.
  • If accredited investors are participating in the Offering, Rule 506 (c) of Reg. D will enable Issuers to issue Securities with no limit.
  • Investors can be offered any type of Security virtually, through a 506 (c) Private Placement. This includes Equity interests like preferred stock, common stock or membership interest.
  • There is a questionnaire which must be completed by investors participating in 506 (c) Private Placement.
  • Most importantly, the accredited investors in a 506 (c) Private Placement are required to provide third-party verification as testimonials that they qualify as investors. The issuer communicates the means of the verification standards to the Investors and it involves either tax returns or accountant’s statements or both.

Comparatively, Rule 506 (b) of Regulation D can be considered a “safe harbor”. The standards that a company rely on to meet the set requirements are relatively objective. To conduct an offering under the Rule 506 (b), companies can raise an unlimited amount of money and can also sell any number of accredited investors. However, there are requirements for offering under the Rule 506 (b) which are:

  • No “general solicitation” (advertising) to market the securities.
  • The number of non-accredited investors cannot exceed 35. (the non-accredited investors must meet the legal standard of being sufficiently informed and experienced in all financial and business undertakings to enable them judge the risks of the potential investment)

For the non-accredited investors who are participating in the offering, the company conducting the offering should:

  • Give the non-accredited investors the documents that contain the same information as indicated in Regulation A offerings. The company may not provide specific disclosure documents but to accredited investors but if it chooses to, this information must also be made available to non-accredited investors.
  • Give non-accredited investors information of financial statement as required in Rule 506 (b)
  • Offer any information and answer any questions from potential purchasers from non-accredited investors.

Under Rule 506 (b), the Securities Act requires a federal preemption from registration and qualification though the States still requires notice filings and collects state fees. A company must file a notice with the Commission on Form D at least 15 days after the first securities in the offering sale.

Rule 506 (b) offer purchases “restricted securities”. These offerings are subject to “bad actor” disqualification provisions. The Security Act.

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