What is Reg D 506?
Companies that are offering securities can make use of Rule 506 of Regulation D. This Rule provides two exemptions for companies who are offering securities and doesn’t require them to register the offerings with the Securities and Exchange Commission (SEC).
By making use of Rule 506, companies can raise unlimited amounts of capital, which is great for both startups and more established businesses alike.
Read the rest of this article to learn more about Reg D 506 and how it works.
What are the Two Exemptions Under Reg D 506?
The two exemptions under Reg D are:
- Rule 506(b)
- Rule 506(c)
Here is a detailed rundown of them.
Rule 506(b)
This rule provides exemption for private offerings, but companies have to meet the following requirements:
- The company isn’t allowed to make use of general advertising or general soliciting to market the securities offerings.
- The company can sell its securities to an unlimited number of accredited investors.
- They can make use of up to 35 other purchasers.
- Non-accredited investors must be sophisticated. This means that they must have enough knowledge of and experience in financial matters so that they enter into the investment well informed of risks.
- Information the company provides to investors must not violate any rules or laws, such as by including misleading information.
- The company must provide disclosure documents if non-accredited investors are involved.
- The company needs to be ready to answer potential investors’ questions.
- Companies will have to file a Form D with the SEC within 15 days of their first sale.
Rule 506(c)
Rule 506(c) has different requirements for companies to ensure they meet. These include the following:
- The company can use general solicitation and advertising to market the offering.
- Purchasers must be accredited investors.
- The company needs to take “reasonable steps” to verify that investors are accredited. The SEC provides a range of non-exclusive verification methods, such as reviewing tax returns and bank statements.
- As long as companies meet the requirements, they don’t have to register their offering with the SEC.
- They will have to file a Form D within 15 days of selling their first securities.
What is an Accredited Investor?
Although this isn’t an exhaustive list, here are some examples of criteria an investor needs to meet to be considered accredited.
- An accredited investor can be an SEC-registered broker-dealer.
- They can be a charitable organization, corporation, or Limited Liability Company (LLC) with assets of more than $5 million.
- A person who has a net worth or joint net worth with a partner that’s equal to at least $1 million is considered accredited.
- A person with income over $200,000 earned in both of the two previous years, or a joint income with a spouse that’s more than $300,000, is accredited. They need to expect that they will earn the same in the current year.
- An accredited investor can be a trust containing assets of over $5 million that isn’t established with the sole goal of acquiring the securities. Their purchases are made by a sophisticated person who has knowledge and experience in financial matters.
- A person who has professional licenses, such as Series 7, Series 65, and Series 82, can be an accredited investor.
What Happens if You Violate Rule 506?
If you don’t comply with Rule 506, you face a range of legal risks. These include the following:
- “Bad actor” disqualification. People could be prohibited from raising capital in future under exemptions.
- Rescission. If you don’t comply with registration requirements, investors have the opportunity to get back their investment, with interest.
- Investment risks. Once you have been non-compliant, or you’ve committed other violations, your investors could be put off from investing in your company, which could pose issues for your company’s fundraising efforts in the future.
Do State Laws Apply to Reg D 506?
Complying with the SEC’s rules is only one part of being compliant. Companies need to consider the state-specific laws that could govern the offering. However, with Rule 506(b) and Rule 506(c), the offering isn’t subject to state registration or qualifications.
Rule 506 offerings are considered covered securities, so states can’t require merit reviews or registration. That said, they can expect notice filings.
Do You Need a Lawyer for Help with Reg D 506?
It’s a good idea to hire a lawyer for Reg D offerings. This is because it can feel complicated, such as with state-specific Blue Sky laws, and you might want to work with a lawyer who gives you peace of mind that you’re not violating any regulations.
A lawyer can help you in the following ways:
- Your lawyer will check that you qualify for the exemption.
- They’ll help you choose between 506(b) and 506(c).
- They’ll ensure you properly structure the offering.
- They’ll prepare and review your offering documents so they’re professionally drafted and legally sound.
- They’ll set up procedures to verify your investor status, if you’re using Rule 506(c).
- They’ll help you file Form D so that it’s done on time.
- They’ll minimize your liability risks.
- They’ll guide you on remaining compliant over time.
Where can you hire a lawyer for Reg D 506 offerings?
If you need a lawyer, you can easily find one on ContractsCounsel, an online legal network that connects you with vetted lawyers. Scrutinize them according to factors such as their years of experience, fields of expertise, and client ratings for previous projects completed on the platform. This will ensure you choose the best lawyer for your needs.
