What is a General Solicitation?
General Solicitation is the act of marketing a capital raise publicly. Rule 506(b) of Regulation D prohibits using general solicitation to market securities. General solicitation is undefined in the statutes or rules, and the Securities and Exchange Commission (SEC) takes a case by case approach. A typical example of general solicitation is telling potential investors in a newspaper the terms of an offering and inviting them to purchase securities.
Rule 502(c) prohibits:
(1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television and radio; and
(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
A pre-existing relationship between the issuer and a potential investor is strong evidence that general solicitation has not taken place. A relationship is pre-existing if the relationship was formed before a securities offering commences, or when it was established through a registered broker-dealer or investment adviser before the registered broker dealer or investment adviser participated in the offering.
A pre-existing relationship may arise in business, social settings, or any other context. The general rule is that the pre-existing relationship must be of some duration and substance. The SEC defines a substantive relationship as “[a relationship] in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.”
The relationship must be established from actual effort to get to know the person, rather than “just checking some box” or waiting a set amount of time.
The SEC has stated in past no-action letters that a third-party broker-dealer may establish a pre-existing relationship with a potential investor by sending the potential investor a generic form that provides enough information for evaluation of the potential investor’s financial circumstances. The generic form may not reference the offering the issuer is undertaking.
When will a general solicitation ruin your ability to rely on Rule 506(b)?
Section 4(a)(2) of Rule 506(b) provides a “safe harbor” for companies that comply with certain requirements. In addition to a prohibition from using general solicitation to market securities, the requirements of the exemption include:
- A company may sell its securities to an unlimited number of “accredited investors” and up to thirty-five other purchasers
- A company’s information provided to accredited investors must not violate antifraud provisions of federal securities laws, and must not contain false or misleading statements
- Companies must make themselves available to prospective purchasers to answer questions
Rule 506 does not limit how many people the issuer may offer securities. However, offers to a significant number of people may be considered a general solicitation resulting in the loss of the private placement exemption.
For example, sending an email to every person in your contacts list stating that you are planning to raise money soon might qualify as general solicitation if the message was sent to enough people to be considered public and the email’s text was related to the offering.
According to an analysis conducted by Kilpatrick Townsend & Stockton LLP of a recent SEC disciplinary action opinion, the SEC has a “zero-tolerance” policy regarding general solicitations. (See: https://www.lexology.com/library/detail.aspx?g=ca800c6d-58dd-42dc-99c8-d3092f9e75490 ) According to the facts of the disciplinary action, an issuer went ahead and accepted funding from accredited investors they had a pre-existing relationship with after they were informed that their prior newspaper advertisement was general solicitation. The issuer thought they could continue with the offering because they had complied with all other requirements of the Rule 506(b) safe harbor. However, in the disciplinary action opinion, the SEC explicitly stated that regardless of whether the other terms with complied with, the company lost its ability to rely on 506(b) as soon as they generally solicited.