Rule 506 of Regulation D: 506(b) vs. 506(c) Funds

Rule 506 of Regulation D provides two distinct exemptions from registration for companies when they offer and sell securities. Companies relying on the Rule 506 exemptions can raise an unlimited amount of money.

Under Rule 506(b), a “safe harbor” under Section 4(a)(2) of the Securities Act, a company can be assured it is within the Section 4(a)(2) exemption by satisfying certain requirements, including the following:

• No general solicitation
• GPs may raise money from an unlimited number of accredited investors and as many as 35 non-accredited investors. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated and must be given additional disclosure documents similar to those typically provided in Regulation A offerings. Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. This means that any information a company provides to investors must be free from false or misleading statements. Similarly, a company should not exclude any information if the omission makes what is provided to investors false or misleading. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well.
• The company must be available to answer questions by prospective purchasers.

Under Rule 506(c), a company can broadly solicit and generally advertise the offering and still be deemed to be in compliance with the exemption’s requirements if:

• The investors in the offering are all accredited investors; and
• The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.

Be sure to understand the nuances that distinguish both types of exemptions, including the types of filing requirements. Compliance will look slightly varied for both Rule 506(b) and Rule 506(c). Many private fund GPs conduct fundraising under Rule 506(b) based on the current structure of LPs they have relationships with. However, given the growing number of accredited investors, Rule 506(c) has become more relevant as well. Give us a call if you'd like to discuss compliance.

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