There are many facts and circumstances that must be considered when conducting a private sale. Section 4(a),(2) of the U.S. Securities Act of 1934, as amended, and its rules and regulations provide an exemption from registration for issuers that offer securities through a private sale. Rule 506 (b) and Rule 506(c) are safe harbors that issuers have access to in order to comply with Section 4(a),(2) of the Securities Act.
Rule 506(b), which allows an issuer to offer securities in a private sale, permits it to do so provided that the issuer does no general solicitation or advertisement; issues securities only to 35 non-accredited investors and files a FormD with the U.S Securities and Exchange Commission (the SEC).
Rule 506(c), which allows an issuer to solicit general solicitation and advertise to issue securities in private offerings, permits the issuer to take reasonable steps to verify that all investors have been accredited and file a Form D with SEC. Any of the following are examples of reasonable verification for natural persons:
No.1 Examining the IRS forms of potential investors for the past two years, and obtaining written confirmation that the potential investor reasonably expects the accredited investor income threshold to be met in the current fiscal year.
No. 2. Reviewing third-party statements (including bank statements, brokerage statements and consumer reports) Documents dated within the last three months showing the potential investor’s assets and liabilities. Also, obtaining written confirmation that the liabilities disclosed fully reflect the investor’s financial obligations
No. No.
Choosing between Rule 506 (b) and Rule 506(c).
The issuer will decide whether or not to comply with Rule 506 (b) or Rule 506 (c). The issuer might choose to comply with Rule 506 (b) if it has existing relationships with potential investors. In this case, the issuer may not feel the need for the public to see the information. High net worth individuals and institutional investors prefer to invest with companies with whom they already have a relationship. However, private offerings in accordance with Rule 506(c) would be preferred by issuers that may need to raise public funds.
Marketing Considerations
No matter whether an issuer relies on Rule 506 (b) or Rule 500(c), they must comply with federal securities laws’ antifraud provisions. This means, among other things that they must ensure that all information given to investors does not include any misstatement of material facts. Issuers often include disclaimers or other clarifying information in offering materials to help potential investors fully understand the risks involved with making an investment.
An example of this is an investment fund issuer providing information on past performance. They should show investors performance returns that include both gross returns as well as returns net of any fees or incentive compensation. Investors should be informed that past performance metrics are not indicative of future performance by issuers. Investors should be informed by issuers of any factors that could materially or negatively affect actual results.
What happens when an issuer violates one of these rules?
An issuer that does not adhere to Rule 506 (b) may still be able to rely on Section 4(a(2) of the Securities Act for private offerings. This exemption is available as long as the offering was made in compliance with the statute. The facts and circumstances will vary. If an issuer relied on Rule 506 (c) but did not adhere to the safe harbour requirements, it could not rely upon Section 4(a),(2) if the issuer had used general solicitation for the offering. Investors would have the right to rescission rights, i.e. they could withdraw their money.
Marketing Tips & Considerations for Private Offers was first published on Attorney at Law Magazine.