Regulation D, specifically Rules 506(b) and 506(c), provides private companies with exemptions from SEC registration requirements for raising capital. These rules allow issuers to offer securities to accredited investors without the need for lengthy SEC approval, but the investor verification requirements under each rule differ significantly. Understanding these differences is crucial for issuers when determining which exemption to choose based on their capabilities and compliance needs.
1. Overview of Rule 506(b) and Rule 506(c)
Rule 506(b) is a more traditional exemption allowing issuers to raise capital from both accredited and up to 35 non-accredited investors. However, the rule prohibits general solicitation and advertising, meaning issuers cannot broadly market their offering to the public. In contrast, Rule 506(c) was introduced in 2013 as part of the JOBS Act and permits general solicitation, allowing issuers to broadly advertise their securities offering. However, Rule 506(c) is only available to issuers who sell exclusively to accredited investors and must comply with stricter verification requirements.
2. Investor Verification Requirements under Rule 506(b)
Under Rule 506(b), while issuers are permitted to raise capital from accredited investors, there is no explicit requirement to verify the accredited status of investors. Issuers can rely on a reasonable belief that an investor is accredited, based on the investor’s representations. Typically, this means that an issuer can take the investor’s word or look at information such as income statements or tax returns to make a determination.
However, there are still risks involved with relying solely on self-certification. If the SEC or other authorities later determine that an investor did not meet the accredited investor criteria, the issuer could face penalties, so even though formal verification is not required, issuers may choose to verify the accredited status of investors as an added layer of protection.
3. Investor Verification Requirements under Rule 506(c)
The key difference with Rule 506(c) lies in its stringent investor verification requirements. Unlike Rule 506(b), Rule 506(c) explicitly mandates that issuers take “reasonable steps” to verify that investors are accredited. This verification cannot rely solely on self-certification or representations. Instead, issuers must gather and review documents like W-2 forms, tax returns, bank statements, or third-party certifications from qualified professionals, such as accountants or attorneys, to confirm the investor’s accredited status.
Issuers using Rule 506(c) also have the option to employ third-party verification services, which can significantly simplify the process and reduce the risk of non-compliance. These services are well-versed in the SEC’s requirements and can help ensure that the verification is both thorough and compliant.
4. Choosing the Right Exemption Based on Verification Capabilities
The choice between Rule 506(b) and Rule 506(c) depends largely on an issuer’s ability to verify accredited investor status and their approach to general solicitation. If an issuer is looking to broadly advertise its offering, Rule 506(c) may be the better choice. However, issuers must be prepared for the more demanding investor verification process.
On the other hand, if an issuer is less concerned about marketing to a large audience and prefers a more straightforward verification process, Rule 506(b) may be a better fit, as it does not require formal verification of accredited investors, though issuers must still ensure that they meet the general requirements of the rule.
Understanding the investor verification requirements of Rule 506(b) and Rule 506(c) is essential for issuers seeking to raise capital while staying compliant with SEC regulations. Rule 506(b) offers flexibility in terms of investor verification but limits general solicitation, while Rule 506(c) opens the door for broad marketing but requires more stringent verification of accredited investors. By evaluating their verification capabilities and marketing needs, issuers can make an informed decision about which exemption best suits their goals.
