The Crowdfunding Rule 506 Distinction

The JOBS Act’s new rules permitting general solicitation and advertising in Rule 506 private placements will become effective on September 23, and there is still some confusion about the difference between crowdfunding and general solicitation and advertising in Rule 506(c) offerings. While Rule 506(c) becomes effective in two weeks, the crowdfunding rules have not been implemented by the SEC.
While the public, and perhaps even some companies, may think of advertising and crowdfunding as the same thing, for the SEC they are not. Crowdfunding is generally defined as raising small amounts of money from many people, rather than large amounts from a few. In recent years, it’s often been used to provide funding for disaster relief, political campaigns, and other “causes” of interest to many people. It is a concept and a technique. The SEC doesn’t regulate concepts, but it does have jurisdiction over companies that choose to apply those concepts, and to those who participate in their application.
General Solicitation and Rule 506(c)
Until now, companies have been forbidden to use general solicitation and advertising to promote their securities. In less than two weeks, that will be permitted in conjunction with offerings of unregistered securities conducted pursuant to Regulation D. Companies are not required to advertise, and if that is their choice, they may use the “old” Rule 506, which does not allow solicitation of any kind. If they wish to advertise, they must use Rule 506(c). In a Rule 506 placement, there may be an unlimited number of accredited investors, and up to 35 unaccredited investors. The new Rule 506(c) permits advertising, but excludes non-accredited investors from participation. In addition, issuers will be expected to make an effort to verify whether their accredited investors qualify for that status. The SEC has suggested several methods they may use to accomplish that.
Companies using Rule 506(c) must also file Forms D fifteen days in advance of the first use of general solicitation for the offering. While the electronic filing of a Form D has been strongly encouraged in recent years, it has not been compulsory. In addition, any written materials to be used in advertising must be submitted to the agency no later than the first day they’re used.
Crowdfunding
The SEC has yet to implement new rules that will permit crowdfunding in Regulation D offerings. Pressed for a date, spokespersons will only say “soon.”
The JOBS Act provides that “crowdfunding portals” or qualified broker-dealers may be used to raise money. The companies receiving the money may not advertise on their own behalf; the issuer can only direct interested parties to the portal being used. The portal operators’ job is only to match investors with issuers. They cannot offer investment advice, solicit sales, or handle investors’ money. They must register with the SEC and FINRA as investment portals.
If a company takes the crowdfunding route, it may raise no more than $1 million every 12 months from that offering or any other offering. In other words, if an issuer uses crowdfunding, it may not float any other kind of offering to raise additional funds until a year has passed.
There will also be strict limits on how much an investor whose net worth is less than $100,000 can spend, which will be the greater of $2000 or 5% of his income. If he’s worth more than that, there is still a maximum investment size of $100,000.
The company will have to provide additional information to the SEC, depending on the amount of money to be raised. If its goal is, for example, $500,000 or more, audited financials will be required.
Implications for Going Public Issuers
General solicitation and crowdfunding will provide new ways for small businesses to attract investors; with luck, they will help them grow more quickly and easily than before. But the rules are complicated, and a failure to understand them could result in securities laws violations. Companies should seek advice from an qualified securities attorney before embarking upon the unknown.