Earlier this year, an earthquake rocked the world of Reg D, finally unlocking the long-held promise of 506(c).
Or did it.
506(c) is not popular. It was created by the SEC in 2013 at the direction of Congress (Section 201(a)(1) of the JOBS Act.) It permits general solicitation for offers, but all sales must be made only to accredited investors. To make sure that the investors are accredited, the SEC, again at Congress’ direction, requires that issuers take “reasonable steps to verify” the accreditation status of each 506(c) investor.
So on paper, 506(c) looks amazing: advertising on the internet, unlimited investors, no offering cap. But yearafteryearafteryear, it underperforms its older sister, 506(b). Why?
The answer securities lawyers usually give is that reasonable steps to verify is annoying. Like a tectonic plate, it pushes against everything it touches, creating pressure and friction and fault lines in the offering process. Investors don’t want to produce two years’ worth of income statements. Nor do they want to give up bank statements and a credit report. These complaints not only make sense but are (mostly) true. Though, I would note that 506(b) requires an issuer to have a “reasonable basis” that investors are accredited, so I’ve always wondered what daylight really exists between 506(b) and (c). (Relatedly, did you know that “check the box” verification in 506(b) does not work to show no general solicitation? I cover this in the next blog.)
Seeking to release the tectonic tension, CorpFin published the Latham No-Action Letter in March. You should read it for all the details (it is more complex than this summary), but, in essence, it provides that if an entity is making an investment commitment of at least $1 million or a natural person is committing at least $200,000, then issuers may rely on written representations from the investor that (a) the investor is accredited and (b) the investment is not being financed by a third party. In other words, the no-action relief allows issuers to add the required representations to their accredited investor questionnaire and, so long as issuers have no reason to disbelieve the reps, 506(c)’s reasonable-steps-to-verify process is complete.
Will the Latham Letter increase the use of 506(c)? Who knows. We need more offering data before I give it a magnitude number on the Reg D Richter Scale.
For what it’s worth, even absent the Latham Letter, I actually really like 506(c) as a funding solution and would be happy to talk with you about using it and the Latham Letter for your next round. (Plus, some broker-dealers, like North Capital, have great accreditation verification tools that make it easy for you to onboard investors in your 506(c).)
