Congress Considers Eliminating Prohibition on General Solicitation in Rule 506 Offerings

On September 15th, Rep. McCarthy (R-CA) introduced HR 2940, the Access to Capital for Job Creators Act which, if passed, would remove the prohibition on general solicitation under Rule 506 of Regulation D. The bill is designed to increase the ability of small businesses to raise capital, but the removal of the general solicitation prohibition would equally benefit hedge funds and other private funds, most of which rely on Rule 506 to raise capital. The bill has now been approved by the House Capital Markets Subcommittee.

Rule 506 of Regulation D is a "safe harbor" for the private offering exemption of Section 4(2) of the Securities Act. The rule permits the sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors who are sophisticated based on their knowledge or experience in finance and business matters. Rule 506 includes a prohibition on the use of any means of general advertising or solicitation, which essentially limits issuers to investors with whom they have a pre-existing relationship. The proposed bill would eliminate this prohibition, allowing issuers to reach a much wider audience of potential investors on a national or even global scale. Many in the industry would support such a change and argue that the existing ban on general solicitation adds little to investor protection, since the ultimate investors would still be required to meet the minimum accreditation and sophistication requirements.

In its testimony, the SEC recognized that the increased use of the internet and other technologies in private offerings has prompted many to question the continued practicality of the prohibition on general solicitation. On the other hand, others support the prohibition on the grounds that it helps prevents securities fraud by limiting the ability of fraudulent issuers to access potential unsophisticated victims. Similarly, the North American Securities Administrators Association (NASAA) expressed concerns in its testimony before the House Capital Markets Subcommittee that removing the general solicitation prohibition would increase the potential for fraud and argued that prohibiting general solicitation in Rule 506 offerings helps ensure the private nature of such transactions.

Past proposals to eliminate or limit the general solicitation prohibition have failed in the face of similar challenges, and while ultimate passage remains uncertain, we will continue to monitor the bill as it moves through Congress. For additional information please contact Brent Cunningham, Compliance Consultant, at brent.cunningham@corecls.com or Zachary Rosenberg, Compliance Consultant, at zachary.cunnngham@corecls.com or call (619) 278-0020.