By Trevor Crow

www.biztaxbuzz.com

The ability to engage in general advertising in Rule506(c) offerings should change the way manyissuers raise money.

Issuers now have the opportunity to reachpotential investors beyond their networks, friendsand family, and the connections that their broker-dealers have.

Issuers can now take advantage of communicationplatforms and marketing tools such as the internet,newspapers, television and radio.

Using general solicitation, however, will createsome corollary implications that I address below.

The new requirement that issuers must take“reasonable steps to verify” accredited investorstatus raises privacy concerns.

Issuers who use general advertisement will have torequest private financial information frompotential investors, or will have to find otheracceptable ways to demonstrate and documentthat each investor qualifies as an accreditedinvestor.

Asking for this information, may raise privacy andsecurity concerns and may deter potentialinvestors from investing in the offering.

In light of the new “bad actor” disqualification rules and the exception forissuers who take reasonable care in the due diligence process, issuers willneed to implement due diligence and verification procedures todetermine whether the issuer, any placement agent, or any other coveredperson is, or during the applicable look- back period was, subject to a“disqualifying event.”

Registered broker- dealer firms and their employees who have beensubject to certain disqualifying events will not be able to assist with Rule506 offerings without an SEC waiver.

Obtaining questionnaires from directors and officers and 20% or greaterowners should be considered by issuers.

And requiring placement agents and other covered persons to provideappropriate contractual representations should also be considered.

In addition, further due diligence may be appropriate such as, judgmentsearches and review of broker- dealer compliance records.

Many employment agreements with executive officerscontain a “for cause” provision that allows the Company toterminate such executive.

These executive employment agreements typically haveconsequences for a termination for cause.

While the definition of “cause” often contemplates a felonyconviction or other acts of moral turpitude, an act ofdisqualification event under Rule 506(d) may not fit withinthe definition.

Thus, it is prudent to consider whether a disqualificationevent under Rule 506(d) for bad actors should be added tothe definition of “cause.”

Otherwise, the issuer may be stuck in the unenviablepositions of having to determine whether to terminate anexecutive without cause or being unable to rely on Rule 506when raising money.

The bad actor rule under Rule 506(d) prohibits a company from usingRule 506 if any of its directors is involved in any of the disqualifyingevents listed in the rule.

The issue to consider with this rule is that directors are elected by theshareholders, not by the Company.

In other words, company management is not always in control of whogets elected as a director.

In the case of new directors, one solution may include asking potentialdirectors to disclose any disqualifying events in hopes that this willreduce the likelihood of this person being elected as a director.

However, there remains an issue with directors who engage in adisqualifying event while on the board.

For both scenarios, issuers should consider amending their articles orbylaws to include director qualification provisions that prohibit anydisqualifying events under 506(d) and these disqualification requirementsshould be a continuing obligation, such that the director must meet therequirements at all times while serving as a director.

When using general solicitation for an offering,issuers should consider how the disclosureinformation provided in any advertisement willimpact the Company’s brand.

Additionally, issuers must consider theinformation on its website in advance of andduring a private offering using general solicitation,because this information will be deemed a part ofthe general solicitation.

Finally, issuers should be prepared to address anyinaccurate reporting from the media that is basedon the publicly- disclosed information.

Issuers should consider the consequences of failure to raise all themoney they need in an offering using general solicitation underRule 506(c).

Remember that a Rule 506(c) offering using general solicitationcan only be sold to accredited investors.

If the issuer later determines that it needs to sell to unaccreditedinvestors after commencing a Rule 506(c) general solicitationoffering, the issuer may be left without any exemption from theregistration requirements of the Securities Act.

If an issuer needs to make a follow- on offering to make up thedifference, it may be a long time before the issuer is able to useanother private placement.

Further, early stage issuers often need to raise capital throughprivate placements regularly and thus must consider possibleintegration of offerings conducted within a 6- month period.

This may seem obvious, but it’s worth pointing outthat the anti- fraud rules under the securities lawsfor making material misrepresentations oromissions in connection with securities offeringsapply to general solicitation offerings under Rule506(c).

Issuers should carefully consider the form, content,and distribution of all advertising and solicitationmaterials.

This includes any materials communicated usingthe internet and social media platforms. Issuersshould expect the SEC to scrutinize thesecommunications.

The exemption from registration to offeringsmade under Rule 506 are authorized by Section4(a)(2) of the Securities Act which is anexemption for non- public offerings.

In the past issuers who were unable to satisfythe requirements of the Rule 506 safe harborcould seek to qualify under the Section 4(a)(2)statutory exemption for private offerings.

However, this fallback position is not availablefor general solicitation offerings under Rule506(c).

Issuers should consider the need to protect tradesecrets and other intellectual property while disclosingenough information for investors to make aninvestment decision.

Especially in light of the America Invents Act, whichcreated a total shift in the patent regime from the “firstto invent” rule to a “first to file” rule.

In the past, private placements were to a selectedgroup of individuals who could more easily be boundby non- disclosure agreements (NDA).

With a general solicitation offering it may be moredifficult to ensure that everyone is bound by an NDA.

Using general solicitation in a Rule 506(c)offering will come at a price.

The challenge will be to consider all of theseconsequences against the benefits of generalsolicitation to determine whether a Rule 506(c)offering is the best route under the particularcircumstances.