Rule 506 of Regulation D
Rule 506 of Regulation D is considered a “safe harbor” for the private offering exemption of Section 4(a)(2) of the Securities Act. Companies relying on the Rule 506 exemption can raise an unlimited amount of money. There are actually two distinct exemptions that fall under Rule 506.
Under Rule 506(b), a company can be assured it is within the Section 4(a)(2) exemption by satisfying the following standards:
- The company cannot use general solicitation or advertising to market the securities;
- The company may sell its securities to an unlimited number of “accredited investors” and up to 35 other purchases. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment; (NB, because of this limitation on non-accredited investors, and issues relatiing to non-accredited investors, most issuers only permit accredited investors to participate.
- Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that are generally the same as those used in registered offerings. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well;
- The company must be available to answer questions by prospective purchasers; and
- Financial statement requirements are the same as for Rule 505.
Under Rule 506(c), a company can broadly solicit and generally advertise the offering, but still be deemed to be undertaking a private offering within Section 4(a)(2) if:
- The investors in the offering are all accredited investors; and
- The company has taken reasonable steps to verify that its investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.
Companies relying on the Rule 506 exemption do not have to register their offering of securities with the SEC, but they must file what is known as a “Form D” electronically with the SEC after they first sell their securities.
Purchasers in a Rule 506(b) offering receive “restricted securities.” A company is required to file a notice with the Commission on Form D within 15 days after the first sale of securities in the offering. Although the Securities Act provides a federal preemption from state registration and qualification under Rule 506(b), the states still have authority to require notice filings and collect state fees.
Rule 506(b) offerings are subject to “bad actor” disqualification provisions.
For more information about the private placement process, read SECLaw.com‘s Introduction to Private Placements, as well as the SEC’s Fast Answers for Rule 504, 505 and 506, and the SEC’s brochure, Small Business & the SEC.
Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.