August 6, 2015 was a productive day for the Staff of the Securities and Exchange Commission’s Division of Corporation Finance on the issue of the prohibition on general solicitation in the context of online private offerings under Rule 506(b). My last blog post, entitled “It’s Complicated”: Establishing “Preexisting Relationships” with Prospective Investors, analyzed the Citizen VC no-action letter delivered that day dealing with establishing pre-existing relationships with investors online to demonstrate the absence of general solicitation in a Rule 506 offering. On the same day, the Staff provided additional guidance on the issue of general solicitation in the form of new Compliance and Disclosure Interpretations (“CDIs”).
Rule 502(c) promulgated under the Securities Act of 1933, as amended, prohibits an issuer from offering or selling securities by any form of general solicitation or general advertising when conducting certain offerings intended to be exempt from registration under Regulation D. The prohibition on general solicitation has been perceived as perhaps the single biggest obstacle to raising capital in the private markets. In September 2013, the SEC released final rules for a new offering exemption contained in Rule 506(c) that permits general solicitation efforts, provided securities are sold only to accredited investors and the issuer uses reasonable methods to verify that each purchaser is an accredited investor. What constitutes reasonable verification methods will depend on the facts and circumstances of each case, but generally involves a more intrusive inquiry than an offering under traditional Rule 506(b), which is why most private offerings are still being conducted under Rule 506(b) despite the prohibition on general solicitation.
The new CDIs come in the form of Q&As, some of which provide official confirmation of existing practice while others provide new flexibility in online offering activities. Here’s an outline of the new CDIs:
Factual Business Information
Factual business information that does not condition the public mind or arouse public interest in a securities offering is not deemed an offer and may be disseminated widely. In the new guidance, the Staff stated that factual business information is a facts and circumstances concept, but is typically limited to information about the issuer’s business, financial condition, products or services, and generally does not include predictions, projections, forecasts or opinions with respect to valuation of a security, nor for a continuously offered fund would it include information about past performance of the fund.
The Staff confirmed that it is possible for angel investors who have a relationship with an issuer to make introductions to other prospective investors in their personal network and share information about a securities offering without such issuer being deemed to engage in a general solicitation. Whether or not a general solicitation has occurred requires a facts and circumstances analysis, but an issuer could rely on such network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication.
Establishing “Pre-Existing” and “Substantive” Relationships
A relationship with an offeree is “pre-existing” for purposes of demonstrating the absence of general solicitation under Rule 502(c) when the relationship was formed prior to the commencement of the securities offering or, alternatively, when it was established through either a registered broker-dealer or investment adviser prior to the registered broker-dealer or investment adviser participating in the offering. Similarly, a relationship is “substantive” for purposes of demonstrating the absence of general solicitation under Rule 502(c) when the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does in fact evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.
Whether or not “demo days” or “pitch days” constitute general solicitation is also – you guessed it – a facts and circumstances question. If the presentation does not discuss the securities being offered, the securities laws are not implicated. Where the presentation does discuss the securities being offered, however, attendance at the demo day or pitch day should be limited to persons with whom the issuer or the organizer of the event has a pre-existing, substantive relationship or who have been contacted through an informal, personal network as described above under “Angel Investors”. For more on this issue involving demo days, see my previous blog post “Will Your Demo Day Presentation Violate the Securities Laws?”.