SEC Rule 506(c) does not make soliciting investors through a database of pre-screened investors a general solicitation. If soliciting investors through these services has not been a general solicitation in the past, soliciting investors through these services (assuming they don’t change) will not be a general solicitation going forward because of the adoption of Rule 506(c).
Using Reasonable Steps when Verifying Accredited Investors from a Database of Pre-Screened Accredited Investors
In the final SEC Regulations implementing Rule 506(c), the SEC wrote this passage when describing what kinds of reasonable steps issuers of securities need to take to verify a purchaser’s status as an accredited investor when a general solicitation has occurred: “[a]n issuer that solicits new investors through a website accessible to the general public, through a widely disseminated email or social media solicitation, or through print media, such as a newspaper, will likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party.” Many, including this author (see related blog post What is a General Solicitation?), have feared that the SEC had just changed the standards for what constitutes a general solicitation. Soliciting new investors from a database of pre-screened accredited investors—that sounds a lot like the services that Gust, AngelList, EquityNet and other Internet-based portals offer, and an issuer would only need to take reasonable steps to verify accredited investor status from new investors solicited from a database of pre-screened accredited investors if the issuer has made a general solicitation. This passage is disturbing, to say the least.
SEC Does Not Publish New General Solicitation Guidance
But it is not the case that soliciting new investors from a database of pre-screened accredited investors will automatically be a general solicitation. The 506(c) adopting release is not intended to change or provide new guidance with respect to the general solicitations and Rule 502(c), other than to provide that the prohibition against general solicitation in Rule 502(c) will not apply to general solicitations made in reliance on Rule 506(c), provided that all purchasers of securities are accredited investors. The amendment to Rule 506 “does not amend or modify the requirements relating to existing Rule 506(b).” Rule 506(b) remains unchanged by the adopting release for Rule 506(c). If the solicitation was not a general solicitation and thus permitted under Rule 506(b) before adoption of Rule 506(c), the solicitation will not be a general solicitation and will continue to be permitted under Rule 506(b) after the adoption of Rule 506(c), and there is a body of authority indicating that solicitations though Internet websites to pre-qualified accredited investors, if done properly, will not be general solicitations.
SEC Confirms Existing General Solicitation Authority
In the Rule 506(c) adopting release, the SEC confirms and cites this authority. See footnote 67 on page 18 of the adopting release,referencing Release No. 33-7856 (noting that “one method of ensuring that general solicitation is not involved is to establish the existence of a ‘pre-existing, substantive relationship’” and that “there may be facts and circumstances in which a third party, other than a registered broker-dealer, could established a ‘pre-existing, substantive relationship’ sufficient to avoid a ‘general solicitation’”). Release No. 33-7856 references additional SEC authority on when a general solicitation does or does not occur, for example, the IPOnet No Action Letter of July 26, 1996 and the Lamp Technologies No Action Letter of May 29, 1997, indicating that an Internet matchmaking service may be used to create the necessary substantial, pre-existing relationship with potential investors to prevent a general solicitation.
More recently, KL Gates has confirmed in a published legal opinion for AngelList that companies may post information relating to financings on the AngelList website without making a general solicitation, therefore preserving the Rule 506(b) exemption for private placements.
All of this is still valid authority on when a general solicitation occurs (note, however, that only AngelList is entitled to rely on the KL Gates opinion). Perhaps the SEC could have used a different fact scenario to describe what kinds of reasonable steps are required in different situations when a general solicitation is made, but that’s all it was doing: describing how reasonable steps can vary depending on the circumstances when companies make a general solicitation. The SEC did not say solicitation of new investors through a database of pre-screened accredited investors is a general solicitation.
Image credit: CC by kimba