As previously examined on our blog, new SEC regulations going into effect on September 23rd will have a huge effect on the state of equity crowdfunding. In order to help the public better understand these upcoming rules, lawyers at Baker & Hostetler published an explanation of the SEC rules. Here are some of the takeaways from their analysis.
Rule 506 Background
Rule 506 in general allows businesses to raise capital through the selling of securities. Under Rule 506 there is no limit on the size of the offering, which distinguishes it from other offerings made under Reg D rules.
Rule 506(c) is the new rule to be implemented by the SEC on September 23, 2013. The catalyst for this rule was The Jumpstart Our Business Startups (JOBS) Act signed by President Obama in April of 2012. Title II of the JOBS Act specifically allows for general solicitation of 506 offerings which would make online accredited investor crowdfunding easier to conduct. Though the JOBS Act was signed over a year ago, regulations from the SEC are only now being passed down.
With the soon to be implemented Rule 506(c) one of the major changes is that you can advertise the sale of your securities. This was not allowed previously under 506(b), as a company’s equity could only be sold to individuals who have a pre-existing relationship with the startup (like family or friends). General solicitation brings a host of new changes along with it.
Verification of Accredited Investors
One of the major changes under the new Rule 506(c) is that all investment in startups must come from accredited investors, as opposed to previously under 506(b) when the round could include up to 35 unaccredited investors. Under 506(c) small businesses must also take “reasonable steps to verify that such purchasers [of equity] are accredited investors.” Under 506(b) there is no such requirement, beyond simply collecting the investor’s rep and warranty. These changes have led to growth in the ecosystem of providers that automate the verification of accredited investor status. As these services prevent the issuer actually seeing the investor’s financial information, they could go a long way to addressing the concerns of angel investors who do not want to expose their private financial history to issuers receiving their investment.
Broker-Dealers and State Laws
Rule 506(c) also has implications for the relationship between broker-dealers and state-level enforcement. Under federal regulations, those running an online platform that hosts the offering information pursuant to 506(c) does not have to register as a broker-dealer with the SEC, so long as it does not collect transaction based revenue. Considering that general solicitation could open investment opportunities across the US, individuals running platforms may need to follow the regulations of different states and potentially register as broker-dealers in some states. Consult with legal counsel on whether you will need to register in certain states in order to act as an intermediary for the offering.
- General solicitation will soon be allowed
- Reasonable steps must be taken to verify accredited investors status under 506(c)
- Pay close attention to the interactions between state laws and the federal rules, especially if you are going to be operating a portal.
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