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The JOBS Act: The Quiet 506

William Carleton, Contributing Editor, VCExperts


The phrase "the quiet 506" is not original with me. Joe Bartlett coined it.

It refers to the existing Rule 506 under Regulation D. The securities exemption relied on for most private financings. An exemption prohibiting the use of general solicitation or general advertising.

Because that prohibition is today honored mostly in its breach - not just in California, but wherever startup pitch events are tweeted - the SEC's rules to lift the ban on general solicitation and general advertising are arriving none too soon.

But what a brutal trade-off may be in store for those few remaining serial entrepreneurs who have disciplined themselves to raise money only from accredited investors with whom they have a pre-existing business relationship.

This is because the lifting of the general solicitation ban will be accompanied by new rules requiring "verification" of each accredited investor's accredited status. And because it's possible that the verification rules will stick even to those startups who won't include among their investor base any persons the founders don't already know.

That said, it's also possible that the SEC's rules will bifurcate 506, requiring a new regime of verification for deals offered broadly to accredited investors by public means, and permitting the existing standards to apply when issuers restrict their offerings to accredited investors they already know.

I have been calling the two sub-rules "new 506" and "old 506," but Joe's phrase is better for the latter. It characterizes what it is about the existing rule that makes verification superfluous: there is no public offering, and no attendant hype; the investors understand that the issuer is claiming an exemption based in part on the investors' reps; and the investors know where the CEO of the company lives.

Some lawyers are saying, why bother with bifurcating? Follow the new verification regime just in case. (Subtext: hardly anyone today is strictly complying with the general solicitation prohibition; when the bugaboo is off the books, can anyone really be trusted to keep quiet?)

There may be some merit in changing the paradigm wholesale all at once. But how ironic, if the JOBS Act takes those angels concerned for their privacy altogether out of startup financing.

Photo: elycefeliz / Flickr.


William Carleton

Bill is a member of McNaul Ebel Nawrot & Helgren PLLC, a Seattle law firm. He blogs every day at http://wac6.com.