Rule 506(c)

For seasoned investment professionals transitioning from institutional roles to launching their own funds, navigating the regulatory landscape is a critical first step. Rule 506(c) of Regulation D under the Securities Act offers a powerful exemption that can significantly impact a fund’s capital raising strategy and operational flexibility.

This comprehensive guide will dissect the nuances of Rule 506(c), exploring its requirements, exemptions, and strategic implications for hedge fund managers. We’ll also delve into the practicalities of launching a 506(c) offering and provide actionable insights for getting your fund off the ground.

Rule 506(c) is a safe harbor provision under Regulation D that allows issuers to raise an unlimited amount of capital through general solicitation and advertising, provided that all purchasers are accredited investors and the issuer takes reasonable steps to verify their status.

This rule differs significantly from its predecessor, Rule 506(b), which prohibits general solicitation but allows up to 35 non-accredited investors. For a detailed comparison of these two exemptions, refer to our analysis of 506(b) vs 506(c).

To qualify for the Rule 506(c) exemption, issuers must adhere to specific requirements set forth by the SEC. These criteria, established in 2013, include:

1. Accredited Investors Only: All purchasers must meet the SEC’s definition of an accredited investor. This includes individuals with annual income exceeding $200,000 (or $300,000 with a spouse) for the last two years, or a net worth over $1 million (excluding primary residence).
2. Reasonable Steps for Verification: Issuers must take reasonable steps to verify the accredited status of investors, going beyond mere self-certification. This may involve reviewing financial statements, tax returns, or obtaining third-party verification.
3. General Solicitation Permitted: Issuers can engage in general solicitation and advertising of the offering. This includes online advertisements, social media marketing, and public presentations.
4. Form D Filing: A notice must be filed with the SEC on Form D within 15 days after the first sale of securities. This form discloses basic information about the offering and the issuer.
5. Restricted Securities: Securities sold under Rule 506(c) are considered “restricted” and have limitations on resale. Investors typically must hold these securities for at least one year before reselling.
6. Bad Actor Disqualification: Certain “bad actors” are disqualified from participating in 506(c) offerings. This includes individuals with specific criminal convictions or regulatory orders.

For hedge fund managers, Rule 506(c) offers a powerful tool for capital raising, particularly for those looking to expand their investor base beyond traditional networks. Key considerations include:

1. Broader Marketing Reach: The ability to engage in general solicitation allows managers to cast a wider net for potential investors. This can be particularly beneficial for emerging managers without extensive pre-existing networks.
2. Accredited Investor Focus: While limiting the investor pool to accredited investors only, this requirement aligns well with most hedge fund strategies and helps ensure a sophisticated investor base.
3. Verification Process: Managers must implement robust procedures to verify accredited investor status. This can be more time-consuming but provides added protection against regulatory scrutiny.
4. Impact on Fund Structure: The choice between 506(c) and other exemptions can influence fund structure, fee arrangements, and overall strategy. For example, managers may need to adjust their minimum investment amounts or fee structures to accommodate a potentially broader investor base.
5. Regulatory Scrutiny: While 506(c) offerings provide more marketing flexibility, they may also attract increased regulatory attention. Managers should be prepared for potential SEC examinations and maintain meticulous records of their verification processes.
6. Performance Reporting: With the ability to advertise, managers must be cautious about how they present performance data to ensure compliance with anti-fraud provisions.

For fund managers considering a 506(c) offering, careful planning and execution are essential. Key steps include:

1. Develop a clear investment strategy and operational plan aligned with the 506(c) framework. This should include a detailed marketing strategy that leverages the general solicitation allowance.
2. Engage experienced legal counsel for fund formation and compliance. Given the complexities of 506(c) offerings, expert guidance is crucial.
3. Implement robust investor verification procedures. This may involve partnering with third-party verification services to streamline the process.
4. Prepare comprehensive offering documents, including private placement memoranda and subscription agreements. These documents should clearly disclose the risks associated with the investment and the fund’s strategy.
5. Develop a marketing strategy that leverages the general solicitation allowance while complying with anti-fraud provisions. This may include creating a website, producing marketing materials, and planning investor presentations.
6. File Form D with the SEC within 15 days of the first sale. Ensure all required information is accurately reported.
7. Establish strong operational infrastructure, including selecting service providers for fund administration, audit, and legal support.

What is the difference between a 506(b) and a 506(c) offering?

The primary differences are:

1. General Solicitation: 506(c) allows general solicitation and advertising, while 506(b) prohibits it.
2. Investor Qualifications: 506(c) is limited to accredited investors only, while 506(b) allows up to 35 non-accredited but sophisticated investors.
3. Verification Requirements: 506(c) requires issuers to take reasonable steps to verify accredited investor status, while 506(b) allows for self-certification.

What is a 506(d) offering?

There is no specific “506(d) offering.” This term likely refers to the “bad actor” disqualification provisions that apply to both 506(b) and 506(c) offerings, which are outlined in Rule 506(d).

How to become a 506(c) accredited investor?

An individual can’t “become” a 506(c) accredited investor. Rather, they must meet the SEC’s definition of an accredited investor, which includes income or net worth thresholds. Fund managers must verify this status for 506(c) offerings.

What is the status of 506(c)?

As of 2024, Rule 506(c) remains an active and widely used exemption. The SEC continues to monitor its use and impact on the private capital markets.

What is the Rule 506(c) adopting release?

The adopting release refers to the SEC’s final rule document that implemented Rule 506(c) in 2013. This release provides detailed guidance on the rule’s requirements and the SEC’s rationale for its adoption.

For emerging managers, partnering with an experienced fund administrator can streamline many of these processes, allowing you to focus on strategy and capital raising. Repool’s hedge fund administration platform offers tailored solutions for 506(c) offerings, ensuring you remain compliant while optimizing your operational efficiency.

Rule 506(c) represents a significant opportunity for hedge fund managers to expand their capital-raising capabilities. By understanding its nuances and leveraging appropriate resources, managers can position themselves for success in the competitive alternative investment landscape. However, the increased flexibility comes with added responsibilities and potential scrutiny. Managers must carefully weigh the benefits against the compliance requirements when deciding whether a 506(c) offering is right for their fund.