The 7 Not-So-Obvious Implications of General Solicitation Offerings
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The 7 Not-So-Obvious Implications of General Solicitation Offerings

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Using general solicitation in a Rule 506(c) offering will come at a price. The challenge will be to consider all of these consequences against the benefits of general solicitation to determine......

Using general solicitation in a Rule 506(c) offering will come at a price. The challenge will be to consider all of these consequences against the benefits of general solicitation to determine whether a Rule 506(c) offering is the best route under the particular circumstances.

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  • 1. By Trevor Crow www.biztaxbuzz.com
  • 2.     The ability to engage in general advertising in Rule 506(c) offerings should change the way many issuers raise money. Issuers now have the opportunity to reach potential investors beyond their networks, friends and family, and the connections that their brokerdealers have. Issuers can now take advantage of communication platforms and marketing tools such as the internet, newspapers, television and radio. Using general solicitation, however, will create some corollary implications that I address below.
  • 3.    The new requirement that issuers must take “reasonable steps to verify” accredited investor status raises privacy concerns. Issuers who use general advertisement will have to request private financial information from potential investors, or will have to find other acceptable ways to demonstrate and document that each investor qualifies as an accredited investor. Asking for this information, may raise privacy and security concerns and may deter potential investors from investing in the offering.
  • 4.      In light of the new “bad actor” disqualification rules and the exception for issuers who take reasonable care in the due diligence process, issuers will need to implement due diligence and verification procedures to determine whether the issuer, any placement agent, or any other covered person is, or during the applicable look- back period was, subject to a “disqualifying event.” Registered broker- dealer firms and their employees who have been subject to certain disqualifying events will not be able to assist with Rule 506 offerings without an SEC waiver. Obtaining questionnaires from directors and officers and 20% or greater owners should be considered by issuers. And requiring placement agents and other covered persons to provide appropriate contractual representations should also be considered. In addition, further due diligence may be appropriate such as, judgment searches and review of broker- dealer compliance records.
  • 5.      Many employment agreements with executive officers contain a “for cause” provision that allows the Company to terminate such executive. These executive employment agreements typically have consequences for a termination for cause. While the definition of “cause” often contemplates a felony conviction or other acts of moral turpitude, an act of disqualification event under Rule 506(d) may not fit within the definition. Thus, it is prudent to consider whether a disqualification event under Rule 506(d) for bad actors should be added to the definition of “cause.” Otherwise, the issuer may be stuck in the unenviable positions of having to determine whether to terminate an executive without cause or being unable to rely on Rule 506 when raising money.
  • 6.       The bad actor rule under Rule 506(d) prohibits a company from using Rule 506 if any of its directors is involved in any of the disqualifying events listed in the rule. The issue to consider with this rule is that directors are elected by the shareholders, not by the Company. In other words, company management is not always in control of who gets elected as a director. In the case of new directors, one solution may include asking potential directors to disclose any disqualifying events in hopes that this will reduce the likelihood of this person being elected as a director. However, there remains an issue with directors who engage in a disqualifying event while on the board. For both scenarios, issuers should consider amending their articles or bylaws to include director qualification provisions that prohibit any disqualifying events under 506(d) and these disqualification requirements should be a continuing obligation, such that the director must meet the requirements at all times while serving as a director.
  • 7.    When using general solicitation for an offering, issuers should consider how the disclosure information provided in any advertisement will impact the Company’s brand. Additionally, issuers must consider the information on its website in advance of and during a private offering using general solicitation, because this information will be deemed a part of the general solicitation. Finally, issuers should be prepared to address any inaccurate reporting from the media that is based on the publicly- disclosed information.
  • 8.      Issuers should consider the consequences of failure to raise all the money they need in an offering using general solicitation under Rule 506(c). Remember that a Rule 506(c) offering using general solicitation can only be sold to accredited investors. If the issuer later determines that it needs to sell to unaccredited investors after commencing a Rule 506(c) general solicitation offering, the issuer may be left without any exemption from the registration requirements of the Securities Act. If an issuer needs to make a follow- on offering to make up the difference, it may be a long time before the issuer is able to use another private placement. Further, early stage issuers often need to raise capital through private placements regularly and thus must consider possible integration of offerings conducted within a 6- month period.
  • 9.    This may seem obvious, but it’s worth pointing out that the anti- fraud rules under the securities laws for making material misrepresentations or omissions in connection with securities offerings apply to general solicitation offerings under Rule 506(c). Issuers should carefully consider the form, content, and distribution of all advertising and solicitation materials. This includes any materials communicated using the internet and social media platforms. Issuers should expect the SEC to scrutinize these communications.
  • 10.    The exemption from registration to offerings made under Rule 506 are authorized by Section 4(a)(2) of the Securities Act which is an exemption for non- public offerings. In the past issuers who were unable to satisfy the requirements of the Rule 506 safe harbor could seek to qualify under the Section 4(a)(2) statutory exemption for private offerings. However, this fallback position is not available for general solicitation offerings under Rule 506(c).
  • 11.     Issuers should consider the need to protect trade secrets and other intellectual property while disclosing enough information for investors to make an investment decision. Especially in light of the America Invents Act, which created a total shift in the patent regime from the “first to invent” rule to a “first to file” rule. In the past, private placements were to a selected group of individuals who could more easily be bound by non- disclosure agreements (NDA). With a general solicitation offering it may be more difficult to ensure that everyone is bound by an NDA.
  • 12.   Using general solicitation in a Rule 506(c) offering will come at a price. The challenge will be to consider all of these consequences against the benefits of general solicitation to determine whether a Rule 506(c) offering is the best route under the particular circumstances.