Rule 506(b) and 506(c): The Line You Cannot Uncross

Show Notes

• Rule 506 of Regulation D is the most used exemption in American capital formation and the most frequently broken.
• You may generally rely on an investor's written representation that they are accredited, absent facts suggesting otherwise.
• Tax returns, brokerage statements, or a written confirmation from a licensed attorney, CPA, or registered broker-dealer — those are verification.
• That is general solicitation, and it does not convert the offering into a 506(c) offering.
• If someone is introducing investors and being paid based on whether the money closes, that person is very likely acting as an unregistered broker.

Full Transcript

Rule 506 of Regulation D is the most used exemption in American capital formation and the most frequently broken. Most of the breakage happens at one line: general solicitation.

There are two flavors. 506(b) and 506(c).

Under 506(b) you may sell to an unlimited number of accredited investors and up to thirty-five non-accredited investors, provided those non-accredited investors are financially sophisticated and receive specified disclosure. There is no dollar limit. You may generally rely on an investor's written representation that they are accredited, absent facts suggesting otherwise. What you may not do is generally solicit. No advertising. No public posting. No pitching a room of strangers.

Under 506(c) you may generally solicit all you want. Advertise it. Post it online. Speak about it at a conference. The trade is that every purchaser must actually be accredited, and you must take reasonable steps to verify it. A checked box is not verification. Tax returns, brokerage statements, or a written confirmation from a licensed attorney, CPA, or registered broker-dealer — those are verification.

Here is where issuers get into trouble.

They start under 506(b), because that is what counsel advised. Then the CEO posts about the raise on LinkedIn. Or the company emails the deck to a purchased list. Or a founder describes the terms on a podcast. That is general solicitation, and it does not convert the offering into a 506(c) offering. It jeopardizes the 506(b) exemption, because verification was never performed on the investors who already came in.

You cannot cure it retroactively. That line runs in one direction.

Two more things that generate enforcement referrals.

Finders. If someone is introducing investors and being paid based on whether the money closes, that person is very likely acting as an unregistered broker. The exposure attaches to the issuer as well, and it can give investors a rescission right.

And Form D. You file it within fifteen days of the first sale. It is a short form. Failing to file it does not by itself destroy the federal exemption, but it is a marker, and markers accumulate.

Nine years reading these files at the Commission taught me that Regulation D matters rarely begin with fraud. They begin with a solicitation that should not have happened, and an investor who lost money and went looking for a remedy.

Get the flavor right before the first dollar moves.

This is Inside Securities Law. I'm Frederick M. Lehrer. General information, not legal advice.

This transcript is published for general information only. It is not legal advice, and listening to or reading it does not create an attorney-client relationship.

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