SEC + Corporate Governance

In a no-action letter issued on March 12, 2025, the staff of the Division of Corporate Finance (“Corp Fin”) of the Securities and Exchange Commission (the “SEC”) confirmed that, under certain circumstances, issuers may rely on the amount of their investors’ subscriptions to determine “accredited investor” status when conducting a private placement under the safe harbor afforded by Rule 506(c) of Regulation D under the Securities Act of 1933 (the “Securities Act”). As discussed in more detail below, by adopting specified minimum investment thresholds and requiring appropriate representations from investors—steps that are consistent to some degree with the steps that many private issuers, and certainly most private funds, already take—an issuer may confidently engage in general solicitation and general advertising to market its offering under the Rule 506(c) safe harbor without being required to register the offering with the SEC. While the ultimate impact of Corp Fin’s guidance on the U.S. marketing of private issuers, including private funds, remains to be seen, at a minimum it encourages issuers to examine anew the prospect of using general solicitation and public disclosures to generate interest in their privately placed securities.

U.S. Private Placements In Context

To put this development in context, it’s useful to recall the regulatory framework for private placements in the U.S. While the default set by Section 5 of the Securities Act is that any transaction in a security that makes use of instrumentalities of interstate commerce is unlawful unless a registration statement is in effect for the security, Section 4(a)(2) of the Securities Act exempts securities transactions from this registration requirement if they do not involve a “public offering.” In turn, Regulation D provides a safe harbor for issuers, allowing them to ensure that their offerings are not “public offerings,” and thus comply with the exemption under Section 4(a)(2).

Traditionally, an issuer seeking to rely on Regulation D—including most hedge funds, private equity funds, and venture capital funds--followed the requirements of Rule 506(b) of Regulation D. In effect, this means that an issuer can issue its securities without registration to an unlimited number of “accredited investors” (although practical considerations and, for private funds, the requirements of Section 3(c)(1) or 3(c)(7) of the Investment Company Act, constrain the actual number of offerees and investors), so long as the manner of the offering complies with the requirements of Regulation D. Rule 501(a) of Regulation D defines “accredited investor” to include, among others, individuals whose net worth (together or jointly with a spouse or spousal equivalent) exceeds $1,000,000 or whose income exceeds $200,000 in each of the two most recent years (or $300,000 including a spouse or spousal equivalent), and the expectation of those levels of income in the year securities were acquired or an investment commitment is made, as well as entities with assets in excess of $5,000,000 that were not formed for the specific purpose of acquiring the securities offered or making an investment commitment. Critically, however, to rely on Rule 506(b), an issuer is prohibited from engaging (directly or through its agents) in any “general solicitation or general advertising” in connection with the offer and sale of its securities.

But, with the enactment of the Jumpstart Our Business Startups Act (referred to as the JOBS Act) in 2012 and the subsequent adoption of Rule 506(c), issuers were presented with an avenue for privately placing their securities under the Regulation D safe harbor that allowed them to engage in general solicitation and general advertising. Rule 506(c) opened this avenue by focusing not on restricting the manner of the offering, but rather on restricting the investors that actually acquired securities in the offering. In order to rely on Rule 506(c), an issuer must take “reasonable steps to verify” that all purchasers of securities in its offering meet the definition of “accredited investor.” Although the SEC noted in Rule 506(c)’s adopting release that “...if the terms of the [Rule 506(c)] offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party”[1], this concept was not included as part of the rule as adopted. Instead, Rule 506(c) sets out “non-exclusive and non-mandatory” methods for issuers to use to verify a natural person’s status as an accredited investor, which include reviewing the investor’s tax forms for the prior two years; reviewing recent bank, brokerage and other financial statements and credit reports of the investor; or obtaining written confirmation from a broker-dealer, investment adviser, attorney or accountant as to the investor’s qualification.

The hope that Rule 506(c) would significantly facilitate private capital-raising in the U.S. did not fully materialize. Notwithstanding the explicit characterization of the specified verification methods as “non-exclusive and non-mandatory,” inevitably many issuers (and their legal advisers and finance industry counterparties) hewed closely to the specified methods due to a concern that any other method would not be viewed (particularly in the hindsight of a regulator) as “reasonable.” Moreover, for private funds, uncertainty about the interaction of Rule 506(c) with other regulations initially hindered momentum for using the more flexible marketing methods. For example, for private funds that traded commodity interests subject to the CFTC’s jurisdiction, CFTC Letter 14-116 that harmonized the CFTC’s requirements under CFTC Rules 4.13(a)(3) and 4.7 with Rule 506(c) was not issued until 2014, and these rules were not formally amended to expressly reference Rule 506(c) until 2020. Most critically for issuers’ reliance on Rule 506(c), the specified “reasonable” verification methods have been perceived in practice to be sufficiently onerous and intrusive on investors’ sense of privacy that they outweighed the benefits of being permitted to use public communications to market private placements. In the end, after some initial excitement following the introduction of Rule 506(c), many of the largest and most sophisticated private funds found that they were able to successfully market the offering of their securities without resorting to public advertising, and private fund managers found that they preferred to maintain the privacy of their return and portfolio information. The private fund sector settled on relying on the historical cachet of their somewhat exclusive status rather than an outreach to a broader array of investors, many of whom would be prohibited from subscribing in any event.

A Fresh Look Forward with the New Guidance

Corp Fin’s guidance in its recent no-action letter confirms that an issuer “could reasonably conclude that it has taken reasonable steps to verify that purchasers of securities sold in an offering under Rule 506(c) of Regulation D are accredited investors” if the following conditions are met.

First, the issuer’s offering must impose a minimum investment amount (which can be either funded subscriptions, as would be typical for an operating company or a hedge fund, or binding capital commitments, as would be typical of private equity and venture capital funds) of:

• for natural persons, at least $200,000; and
• for legal entities, at least $1,000,000 (or, if the purchaser has fewer than five natural person investors and satisfies the definition of accredited investor solely due to the accredited investor status of all of its equity owners, at least $200,000 for each of the purchaser’s equity owners).

Second, the issuer requires each purchaser (whether a natural person or an entity) in the offering to provide the following written representations:

• a representation that the purchaser is an accredited investor; and
• a representation that the purchaser’s funding of its investment in the issuer (at least up to the required minimum investment amount) is not financed in whole or in part by any third party for the specific purpose of making the particular investment in the issuer.

In addition, from each purchaser that satisfies the definition of accredited investor solely due to the accredited investor status of all of its equity owners (i.e., that relies on Rule 501(a)(8) of Regulation D), the issuer must obtain the following additional representations, which to a certain extent “pass through” the requirements set out above to the purchaser’s own investors:

• a representation that each of the purchaser’s own equity owners has a minimum investment obligation to the purchaser of at least $200,000 for natural persons and $1,000,000 for legal entities; and
• a representation that the minimum investment amount of each of the purchaser’s equity owners is not financed in whole or in part by any third party for the specific purpose of making the particular investment in the issuer.

Third, the issuer must not have actual knowledge of any facts that indicate that any purchaser’s representations as set out above are not accurate. That is, Rule 506(c) will not be available to an issuer who has actual knowledge that (or actual knowledge of facts that indicate that) (i) any purchaser in the offering does not, in fact, satisfy the definition of accredited investor or (ii) the minimum investment amount of any purchaser (and, for each purchaser that satisfies the definition of accredited investor solely due to the accredited investor status of all of its equity owners, that the minimum investment amount of any such equity owner) is, in fact, financed in whole or in part by any third party for the specific purpose of making the particular investment in the issuer.

Some Additional Considerations

Prior Offerings and Bring-Down Certifications. Issuers often have multiple, successive private offerings. While an issuer cannot simultaneously rely on both Rule 506(b) and Rule 506(c), an issuer that has previously conducted an offering in compliance with Rule 506(b) can commence an offering under Rule 506(c) without having to ensure that the accredited investor status of purchasers in the prior offering has been “verified” as required by Rule 506(c). For an issuer with an ongoing offering, as is typical for a hedge fund, it would be advisable to formally document that the Rule 506(b) offering has been concluded and that a new offering under Rule 506(c) has commenced, including by filing a new Form D with the SEC that checks the appropriate box under Item 6 (Federal Exemptions and Exclusions Claims) and making new “blue sky” filings in the appropriate U.S. states.

Some private funds streamline the process for existing investors to increase their investment in the fund by using “short-form” additional subscription documentation in which the investor certifies that the information provided in its original subscription documentation remains accurate and complete in connection with its additional investment. If the existing investor’s prior subscription was made in an offering that relied on Rule 506(b) (and thus the investor did not make all of representations summarized above, did not agree to the requisite investment minimum, and/or the investor’s status as an accredited investor was not otherwise “verified” as required by Rule 506(c)), then in order to rely on Rule 506(c) in the current offering, the additional subscription documentation would need to include the previously omitted representations and agreements.

Note that for purposes of determining if an investor has met the requisite minimum investment amount, a private fund whose investors make commitments (rather than fully funded subscriptions), as is typical for private equity and venture capital funds, looks to the applicable investor’s binding commitment, rather than to its funded investment amounts, both for determining when the investor acquired its security of the issuing private fund and for calculating compliance with the applicable minimum investment thresholds. Consequently, if an investment fund in which investors make capital commitments conducts an offering under Rule 506(b) that is followed by an offering under Rule 506(c), that investment fund will be permitted to draw down capital from investors that subscribed in the Rule 506(b) offering without being required to “verify” their accredited investor status. Similarly, that investment fund would not be required to re-verify upon each draw down the accredited investor status of the investors that subscribed in the Rule 506(c) offering; the relevant time for the verification is the date that the commitment became effective and the investor was admitted to the investment fund, not the date(s) that funding in respect of this commitment is actually provided.

Reverting to Rule 506(b) and Cooling Off. While an issuer may relatively easily migrate from relying on Rule 506(b) to Rule 506(c) for its private offerings, migration in the reverse direction, though also possible, will generally be more involved. If an issuer commences an offering in reliance on Rule 506(c) that markets with public communications, but subsequently determines to switch to a private offering under Rule 506(b) (for which general solicitation and advertising is prohibited), the issuer will need to adhere to a “cooling-off” period before accepting investors without taking “reasonable steps to verify” that they meet the definition of “accredited investor.” Rule 152 under the Securities Act will generally require that more than 30 calendar days elapse before commencing the Rule 506(b) offering and that the issuer have a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the Rule 506(b) offering, that the issuer (or any agent acting for the issuer) either (1) in fact, did not solicit such purchaser through the use of general solicitation; or (2) established a substantive relationship with such purchaser prior to the commencement of the Rule 506(b) offering.

State Blue Sky Considerations. Securities issued under Rule 506(c) are “covered securities,” and thus state regulation of these offerings is limited under the National Securities Markets Improvements Act (known as NSMIA) to requiring a notice filing and paying the requisite filing fees. Nonetheless, while issuers (including private funds) have sometimes been lax about timely filing the required Form D and/or timely submitting it (with payment) to the relevant states under the applicable “blue sky” laws, in the case of an offering relying on Rule 506(b), the issuer could always assert that, notwithstanding the safe harbor provided by Regulation D, the offering was in any event still an exempt offering under Section 4(a)(2) – because the offering simply didn’t involve a general solicitation. But if an issuer relies instead on Rule 506(c) and engages in general solicitations and advertising of its offering, there’s no room for error. If the Form D isn’t timely filed, then Section 4(a)(2) is not available because the offering did involve a general solicitation. Issuers are reminded that the SEC has recently pursued enforcement actions against issuers (including an SEC-registered investment adviser whose private funds failed to file Forms D), emphasizing that an issuer’s failure to file a Form D when required impedes the SEC’s fulfillment of its regulatory mandates.

European Union and other Non-U.S. Private Placements. Many private funds that market in the European Union are able to do so without otherwise complying with the Alternative Investment Fund Managers Directive (known as AIFMD) in reliance on the European investors’ “reverse inquiry” (sometimes referred to as the “own initiative test” or “reverse solicitation”). A private fund that uses Rule 506(c) would have to carefully evaluate whether its use of public marketing methods, even though directed at U.S. investors, would constitute an outreach to European investors that precluded reliance on the “reverse inquiry” construct. Each country in the European Economic Area has its own position on what constitutes an acceptable “reverse inquiry,” but in general the concept is that the initial initiative to invest in the private fund was taken by the investor rather than by the fund’s manager (or an agent acting on the manager’s behalf). If the fund’s manager has presented information in a public forum—for example, the fund manager’s web site, without any procedures to block access by European investors—then this public marketing may be viewed as constituting the fund manager’s initiative, to which the European investor is responding, and thus bring the offering into the AIFMD. Similar considerations may apply to marketing in other non-U.S. jurisdictions.

Application of the Marketing Rule for Registered Investment Advisers. SEC-registered investment advisers should bear in mind that, while the private funds they manage may offer their securities using publicly available marketing materials in reliance on Rule 506(c), these marketing materials nonetheless must comply with Rule 206(4)-1 under the Investment Advisers Act of 1940 (referred to as the “Marketing Rule”). Among other things, the Marketing Rule sets out specific requirements for the presentation of performance information, including rules for the presentation of “hypothetical” performance that focus on the relevance of the information to the likely financial situation and investment objectives of the intended audience of the advertisement. These requirements may be difficult to reconcile with a broad-based, public marketing campaign.