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  • Writer's pictureVinicius Adam

Exemptions to Registering Securities: Rules 506(b) and (c) under Regulation D

If you’re offering stock to US residents that will not be registered as securities, you will likely be relying on a Regulation D exemption like Rule 506.

Regulation D (Reg D) contains two important exemptions (the safe harbor provisions): Rules 506(b) and Rule 506(c). Before getting into the differences between these two exceptions, please take note that you must submit form D (Notice of Exemptions) with the SEC through EDGAR within 15 days of the date of the first sale of a Reg D security and file notice with the state in which the security is sold within 15 days of the first sale.

Below are some important differences between Rule 506(b) and 506(c).

1. Accredited Investors. Current accredited investor requirements are a $200,000 annual income individually ($300,000 jointly) for the last two years with the expectation of earning the same of higher income in the current year OR a $1 million net worth (individually or jointly).

a. In a Rule 506(b) offering, the issuer may sell to an unlimited number of accredited investors and may take the investor’s word that he, she, or it is accredited, unless the issuer has reason to believe the investor is not being truthful.

Furthermore, the issuer can offer to 35 non-accredited investors but “sophisticated”[1] investors. The issuer must provide the non-accredited investors with disclosure documents, including an audit of the fund’s balance sheet

b. In a Rule 506(c) offering, on the other hand, the issuer must take reasonable steps to verify that every investor is accredited. The SEC regulations allow an issuer to rely on primary documents from an investor like tax returns, brokerage statements, or W-2s, but they also allow the issuer to rely on a letter fr

om the investor’s lawyer or accountant. In practice, that’s how verification is typically handled.

Keep in mind that the penalty can be quite severe for not properly verifying whether an investor is accredited, which is why it is recommended that a 3rd party company conduct the verification and provide attorney letters

2. Advertisement. In a Rule 506(b) offering you can advertise only the brand. In a Rule 506(c) offering you can advertise the offering. The regulations on advertising under 506(b) are so strict that it it took some time for the market to become comfortable enough with the lift on the ban and apply for the exemption under subsection (c). On the other hand, under (c), the offeror can advertise by print, television, radio, internet and a number of other media. You can advertise the brand and the deal in order to reach a broad audience in making a capital call.

Offerings under these exemptions do not need to comply with state blue sky laws. It is also important to remember that the offering may be disqualified from relying on 506(b) and 506(c) if certain "bad actors" participate in the offering.

In addition to ensuring that the structure of the private equity firm will serve your purposes and the compliance and marketing documents are properly prepared and filed, the issuer must ensure that it is not creating a securities offering, that the manager is investing funds as opposed to giving investment advice, and observe the restrictions on commissions

Offering securities in order to raise capital is a great option for many firms. Familiarize yourself with the various options and contact an expert that can help you structure the enterprise in the manner that best accomplishes your goals, prepare a business plan, file the appropriate documents, and maintain compliance.

[1] A Sophisticated Investor is one who has such knowledge and experience in financial and business matters that he or she can evaluate the merits and risks of the prospective investment. This may be someone with business experience or superior knowledge of financial and business matters.



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