Rule 506, a provision under Section 4(a)(2) of the Securities Act of 1933, offers a significant pathway for companies to raise capital in the United States. Let’s look into the various aspects of Rule 506, examining its distinct advantages and disadvantages.
Federal Preemption Over State Law
One of the hallmark features of Rule 506 is its federal preemption over state law. This means that with a compliant Regulation D offering, there’s no requirement for state-level registration or exemption filings. The National Securities Markets Improvement Act of 1996 solidified this federal preemption, effectively stripping states of their authority to review offerings under Rule 506. While issuers must file a notice and pay nominal fees in some states, the burdensome state-level review process is largely averted.
Reduced Risk of Losing the Exemption
Under Rule 506, offerings exclusively targeting accredited investors protect the issuer from losing its exemption due to a failure to provide the prescribed disclosures. This exemption, however, requires the careful drafting of a private placement memorandum to mitigate potential violations of anti-fraud provisions under securities laws.
Advertising: Rule 506(b) vs. Rule 506(c)
A pivotal development in 2013 was the SEC’s enactment of rules allowing general solicitation and advertising under Rule 506, leading to the creation of Rule 506(c). This provision enables issuers to publicly advertise their offerings, provided they employ rigorous verification measures to ensure all investors meet accredited status criteria. Conversely, Rule 506(b) restricts advertising but allows for up to 35 non-accredited investors, although with tight compliance requirements.
Advantages and Disadvantages of Rule 506(b) and Rule 506(c)
Rule 506(b) offers flexibility in solicitation methods, enabling issuers to raise an unlimited amount of capital with reduced upfront costs. However, it prohibits general solicitation and entails compliance with state securities laws, making it less attractive for widespread fundraising efforts. On the other hand, Rule 506(c) grants the freedom to advertise offerings but restricts sales to accredited investors, necessitating involved investor verification processes that may deter some potential investors.
The Rise of Rule 506(c)
Despite the additional scrutiny and verification requirements, Rule 506(c) is gaining popularity due to its capacity for widespread advertising and streamlined fundraising. Established sponsors with existing investor networks may still prefer Rule 506(b) for its simplicity, but the growing presence of millennials in the investor landscape is propelling the migration towards Rule 506(c) to leverage modern communication channels.
Rule 506 stands as a pivotal tool for businesses seeking capital infusion, offering a range of options to meet diverse fundraising requirements. Whether navigating the complexities of Rule 506(b) or embracing the advertising freedom afforded by Rule 506(c), issuers must carefully weigh the benefits and drawbacks to determine the most ideal approach for their fundraising efforts.
