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.
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.