The most popular exemption from registration that companies utilize when raising funds in a private offering of securities is the one provided by Rule 506(b) of Regulation D. Rule 506(b) generally provides that companies may procure unlimited investments from an unlimited number of accredited investors provided that such companies do not engage in “general solicitation” during the offering process. This article offers a few legal tips for companies to consider so that they (or their officers or agents, including the broker) do not engage in general solicitation (or general advertising) and therefore jeopardize the fundraising efforts.
As an initial matter, companies relying on Rule 506(b) should make offers and solicitations of investments only to persons with whom they have a “preexisting substantive relationship.” With respect to the “substantive” part, the Securities and Exchange Commission (SEC) released certain interpretative guidance in 2015 stating that a substantive relationship is “one in which the [the company] (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.” While investor self-certification alone is not sufficient, a company may form a substantive relationship with a prospective investor if such person complies with a request from the company (or the broker-dealer acting on behalf of the company) to complete a questionnaire designed to allow the company (or the broker-dealer) to evaluate the prospective investor’s sophistication and financial circumstances. A relationship must also be “pre-existing.” This generally means the company’s relationship with a prospective investor must be formed before an offering begins. If the company is using a broker-dealer to assist in the process, the “pre-existing” requirement is satisfied if the broker-dealer had a relationship with the prospective investor before the broker-dealer became involved in the offering.
Next, the company and its agents must refrain from disclosing the offering materials, or the existence and terms of the offering, to the general public or the press. Using mass communication methods to advertise the offering (mass mailings and cold callings) are not advised. Other ill-advised approaches to publicizing an offering include advertisements on television, radio, websites with unrestricted access or magazines.
As always, monitor and train your employees, agents or representatives to make sure that they do not perform activities during the offering process that may constitute general solicitations.