The document discusses upcoming changes to SEC Rule 506 that will allow for general solicitation and general advertising in securities offerings, as long as all investors are accredited and issuers take reasonable steps to verify accreditation status. Specifically, it notes that (1) the JOBS Act mandated that the SEC revise Rule 506 to permit general solicitation, (2) the SEC has proposed new Rule 506(c) allowing this, and (3) under the proposed rule, issuers must take reasonable verification steps but are not required to use specific methods.

1. GENERAL SOLICITATION
AND STARTUPS
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STARTUPLAWBLOG.COM

2. Joe Wallin
Davis Wright Tremaine LLP
joewallin@dwt.com
joewallin.com
(206) 757-8184
Keith Baldwin
Davis Wright Tremaine LLP
keithbaldwin@dwt.com
(425) 646-6133
Randall Lucas
Applied Dynamite
(617) 905-7467
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3. Private Company Fund Raising
 Suppose you are a private company and
you want to raise money. How do you do it?
 Almost all companies use Rule 506.
 Rule 506 allows you to raise an unlimited
amount of money from accredited investors,
with no SEC or state filings prior to closing.
(Forms D are due after closing, however.)
 As long as you take money from only
accredited investors, there are no specific
disclosure requirements.
 Provided, however, “general solicitation and
general advertising” are disallowed.
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4. Current Rules
 What are general solicitation and general
advertising?
(1) Any advertisement, article, notice or other
communication published in any newspaper, magazine,
or similar media or broadcast over television or radio; and
(2) Any seminar or meeting whose attendees have been
invited by any general solicitation or general advertising.
 So you can’t run an ad in the newspaper (under
the current rules).
 You are supposed to work only through your pre-
existing relationships.
 These rules make raising money difficult. And
companies foot fault all the time. E.g.,
accidentally telling a reporter about a current
and ongoing fundraising.
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5. Why no advertising?
 Why does Rule 506 prohibit general
advertising?
– Because 506 is a safe harbor under the Securities
Act of 1933, Section 4(2), which provides an
exemption from registration for securities offering
which are “not involving any public offering.”
– Advertising or generally soliciting funds is
considered inconsistent with a non-public offering.
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6. Don’t Jump the Gun!
 These rules prohibiting general solicitation and
general advertising are still the current rules.
 You can’t Twitter, use Facebook, etc. to raise
money.
 Just recently, the SEC took enforcement action
against two individuals who ran a social media
campaign to buy a brewery. These guys never
actually collected any money. They only
collected commitments. They still got in trouble.
 The point ─ the current rules are still in effect.
You cannot generally solicit or generally
advertise yet.
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7. JOBS Act changes
 However, the JOBS Act will change this (and
the world of private company financing).
 Here is what the JOBS Act said:
Not later than 90 days after the date of the
enactment of this Act, the Securities and Exchange
Commission shall revise its rules issued in section
230.506 of title 17, Code of Federal Regulations, to
provide that the prohibition against general
solicitations or general advertising contained in
section 230.502(c) [Rule 506] of such title shall not
apply to offers and sales of securities made pursuant
to section 230.506 [Rule 506], provided that all
purchasers of the securities are accredited investors.
(cont’d on next page)
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8. Text of Rule
 Does this mean you’ll be able to run ads in
newspapers, announcing you’re raising
money?
– Yes, but you may not want to for a few different
reasons.
• Heightened verification requirements.
– If you generally advertise or generally solicit, you have
to take reasonable steps to verify that the purchasers
of securities are accredited investors.
• Blue Sky.
– Some states want pre-filings before soliciting funds in
those states.
– E.g., New York.
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9. Text of Rule cont’d
 However, such rules shall require the issuer to
take reasonable steps to verify that
purchasers of securities are accredited
investors, using such methods as determined
by the Commission. Section 230.506 of title
17, Code of Federal Regulations, as revised
pursuant to this section, shall continue to be
treated as a regulation issued under section
4(2) of the Securities Act of 1933 (15 U.S.C.
77(d)(2)).
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10. The New Rules Adoption Process
 Are the SEC rules final yet?
– No.
 Have draft rules been proposed?
– Yes. See here: sec.gov/rules/proposed/2012/33-
9354.pdf.
– The SEC has proposed a new section 506(c).
 Are the new rules going to work?
– There was a lot of worry over what they would say.
– Would they require investors give onerous
disclosure?
 A lot of folks were really worried.
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11. Enabling capital formation vs. protecting investors
 The actual rules say just this regarding the
verification requirement:
“The issuers shall take reasonable steps to verify that
purchasers of securities sold in any offering under this
section 230.506(c) are accredited investors.”
 A lot of people are complaining, on both
sides.
– Securities regulators say the rule doesn’t do what
Congress instructed the SEC to do; that it doesn’t
protect investors.
– On the other side, people are asking for safe
harbors.
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12. SEC authority to define “reasonable steps”
 What the statute said:
“However, such rules shall require the issuer to take
reasonable steps to verify that purchasers of securities
are accredited investors, using such methods as
determined by the Commission.” (Emphasis supplied.)
 What the rules said:
“The issuers shall take reasonable steps to verify that
purchasers of securities sold in any offering under this
section 230.506(c) are accredited investors.”
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13. What Will Happen in the Final Rules?
 We don’t know for sure.
 Probably the final rules will look substantially
similar to the proposed rules, but we won’t
know until we see them.
 We should be happy the proposed rules
weren’t ridiculously onerous.
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14. Newly Proposed Rules
 The new rules require issuers to take
reasonable steps.
 What are reasonable steps?
– Objective determination, based on particular
facts and circumstances of each transaction.
– Example factors:
• Nature of the purchaser and the type of accredited
investor that the purchaser claims to be.
• The amount and type of information that the issuer
has about the purchaser.
• The nature of the offering, such as the manner in
which the purchaser was solicited in the offering,
and the terms of the offering, such as the minimum
investment amount.
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15. SEC Words
– “The more information an issuer has indicating that
a prospective purchaser is an accredited investor,
the fewer steps it would have to take, and vice
versa.”
– “Third-party information that provides reasonably
reliable evidence that a person falls within one of
the enumerated categories.”
– For example:
• The purchaser is a natural person and provides
copies of Forms W-2.
• Verification of a person’s status as an
accredited investor by a third party, such as a
broker-dealer, attorney or accountant,
provided that the issuer has a reasonable basis
to rely on such third party verification.
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16. SEC Words (cont’d)
“The nature of the offering – such as the means
through which the issuer publicly solicits investors –
may be relevant in determining the
reasonableness of the steps taken to verify
accredited investor status.”
“An issuer that solicits new investors through a
website accessible to the general public or
through a widely disseminated email or social
media solicitation would 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, such as a
registered broker-dealer.”
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17. SEC Words (cont’d)
“In the case of the former, we do not believe that
an issuer would have taken reasonable steps to
verify accredited investor status if it required only
that a person check a box in a questionnaire or
sign a form, absent other information about the
purchaser indicating accredited investor status.
In the case of the latter, we believe an issuer
would be entitled to rely on a third party that has
verified a person’s status as an accredited
investor, provided that the issuer has a reasonable
basis to rely on such third-party verification.”
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18. SEC Words (cont’d)
“By way of example, the ability of a purchaser to
satisfy a minimum investment amount requirement that
is sufficiently high such that only accredited investors
could reasonably be expected to meet it, with a direct
cash investment that is not financed by the issuer or by
any other third party, could be taken into
consideration in verifying accredited investor status.”
“[I]f an issuer knows little about the potential purchaser
who seeks to qualify under the natural person tests for
accredited investor status, but by the terms of the
offering require a high minimum investment amount,
then it may be reasonable for the issuer to take no
steps to verify accredited investor status other than to
confirm that the purchaser’s cash investment is not
being financed by the issuer or by a third party, absent
any facts that may indicate that the purchaser is not
an accredited investor.”
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19. SEC Words (cont’d)
“Regardless of the particular steps taken, it
would be important for issuers to retain
adequate records that document the steps
taken to verify that a purchaser was an
accredited investor.”
“Any issuer claiming an exemption from the
registration requirements of Section 5 has the
burden of showing that it is entitled to that
exemption."
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20. “Reasonable belief” standard
Proposed rules do not require issuer to follow uniform
or specified verification methods.
The SEC did not propose a non-exclusive list of
specified methods of satisfying the verification
requirement.
The reasonable belief standard remains:
“If a person who does not meet the criteria for any
category of investor purchases securities in a Rule
506(c) offering, we believe that the issuer would not
lose the ability to rely on proposed Rule 506(c)
exception, so long as the issuer took reasonable steps
to verify that the purchaser was an accredited investor
and had a reasonable belief that such purchaser was
an accredited investor.”
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21. Summary
– No specific method or methods of verifying accredited
status are required under the proposed rules.
• There is no non-exclusive list of specific methods for
satisfying the verification requirements included in the
proposed rules.
• Instead, the rules will require that “[T]he issuer shall take
reasonable steps to verify that purchasers of securities
sold in any offering under this Section [506(c)] are
accredited investors.”
– Issuers relying on the new rules will have to check a box
on the new Form D indicating that they are doing so.
– The new rules do not eliminate the reasonable belief
standard. If a person who does not meet the criteria for
an accredited investor invests in a generally solicited or
advertised offering, the issuer does not lose the ability
to rely on the 506 exemption, so long as the issuer took
reasonable steps to verify that the purchaser was
accredited and had a reasonable belief that such
person was accredited.
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22. Summary
 You can continue to use the existing rules, so long as
you don’t generally solicit or advertise an offering.
 The SEC has created a new rule: Rule 506(c).
– Offerings under the new Rule 506(c) don’t have to comply
with the prohibition on general solicitation and advertising
under Rule 502(c).
– Under new Rule 506(c), general solicitation and
advertising are permissible as long as:
• the issuer takes reasonable steps to verify that the purchasers
of the securities are accredited investors;
• all purchasers of securities must be accredited investors,
either because they come within one of the enumerated
categories of persons that qualify as accredited investors or
the issuer reasonably believes that they do, at the time of the
sale of the securities; and
• all terms and conditions of Rule 501 and Rules 502(a) and
502(d) are satisfied.
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23. The Push and Pull of the Law
 Dodd-Frank made it harder on private
companies to raise money.
– Made it harder to be an accredited investor.
– Imposed bad actor rules.
 JOBS Act tries to make it easier to raise
money.
– General solicitation in 506 offerings.
– Crowdfunding.
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24.  Questions?
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