(This newsletter is not intended to provide legal or investment advice and no legal or business decision should be based on its content. FYI.)
I don’t get it.
As an experienced Managing Broker-Dealer and financial professional, I just don’t get it.
I don’t get why 506(b) private placements are more popular than 506(c) private placements.
- Is it because sponsors think that they are easier?
- Is it because issuers think that they are safer?
- Is it because retail and institutional investors are resistant?
- Is it because selling brokers don’t understand how to write an Accreditation Investor Confirmation (AIC) Letter?
In 2012, President Obama signed into law the JOBS Act, otherwise known as the Jumpstart Our Business Startups Act. Following a significant decline in small business activity in the wake of the Great Financial Crisis of 2008, our United States Congress devised and passed a number of solutions to spur economic growth. The Jobs Act was one of them.
The bill provided for (finally!) the opportunity to generally solicit investors in private placement offerings.
Before this rule was codified by the SEC on July 10, 2013 (yeah, it took a minute), issuers could only sell their securities to investors with whom they had a previous relationship. That meant that issuers needed to limit their offerings to investors they already knew.
With Rule 506(c), issuers can now more broadly market their offerings in “general solicitations” to investors whom they do not know. And they can accept investors with whom they have developed a relationship since after the start of the offering.
To my mind, this was a huge development and a big breakthrough for the private capital markets. But even still, 506b offerings are far more broadly deployed by issuers and sponsors than 506c offerings. Some of the reasons I hear, and I can find, are:
- “…Issuers have access to adequate capital from accredited investors without any resort to general solicitation”
(“Resort?” Really?!) - A perception of “…anticipated reluctance by investors to provide confidential information for purposes of meeting the verification requirement.”
- Concerns by issuers of the cost of compliance in the third-party verification requirements.
- Concerns over scrutiny by the SEC and FINRA regarding non-compliance in the third-party verification process.
I feel that these concerns, sampled above, are simply excuses. And they tend to vilify 506(c) offerings. I think this is because people don’t like change and they fear not understanding a new rule and potentially not following it correctly, thus possibly risking enforcement . That is completely understandable.
But, in fact, TOBIN has seen more enforcement against FINRA firms on 506(b) offerings than 506(c) offerings, especially around lack of compliance with the requirement to sell only to investors with whom the issuer has a “pre-existing, substantive” relationship.
To make Rule 506(c) more accessible and comfortable, the SEC has continued to loosen it, especially with the August 2020 expansion of the definition of “accredited investor” and the length of time that an AIC remains valid (from 90 days to five years!) , making the use of the Rule 506(c) exemption even more logical in private placement offerings.
I will delve more deeply into this topic early next year. It’s the holidays. I am not going to split your brain open too widely at this late point of the year.
But if you are an issuer with one question on your mind – should my offering be a 506(b) or a 506(c)? – please look harder at the C.
Want to talk more? Call me and I will walk you through my rationale and reasoning.
If I don’t hear from you, you will hear from me again next month.
Happy Holidays.
PS – Would you like to read the actual rule? Whenever I want to read the legalese, as a non-attorney, I Google the rule and add the term “ Cornell.” For example, if I want to read the text of Rule 506(c) (which I actually do quite often), I Google “Rule 506(c) Cornell” and the search engine takes me straight to the rule. I hope that tip helps.