As a syndication attorney, this is the second most common problem that I see happening, not only with people I meet for the first time but also the problem that is under a lot of scrutiny by regulators on exactly how it can be fixed and addressed. We’re going to go through that problem: solicitation that occurs with Regulation D, Rule 506(b) offerings.
As an aside, the number one problem is when people assume that what they’re offering is not a security. They’re making investments with private investors who are going to be taking on a passive role, and they’re saying, “Well, it’s friends and family.” That’s the number one problem, and it’s not correct. It is a security, and it needs to be either registered with the SEC or fall under an exemption, like Regulation D.
Let’s move on to the second most common issue in this seven-part series on how to stay out of trouble and in compliance with both the SEC and state regulators.
Here’s what it looks like: There’s a Regulation D Rule 506(b) offering because someone wants to include non-accredited investors in their investment. They don’t know everybody, and that’s where the problem lies. We’re going to talk about solicitation, how it works, what the problem is, and what the real rules are about it. Then we’ll put that in the context of how to be in compliance with the SEC.
Let’s go to a whiteboard so we can outline things a little bit easier. What is solicitation? It falls under Rule 502. “But I thought we were talking about Rule 506(b)?” Yes, we are. Rule 502 is where we have Rule 502(c), as it relates to Rule 506(b). This rule applies to any kind of offering except as provided in Rule 504(b)(1), which no one really uses anymore, or if it falls under 506(c). So we’re talking about Rule 506(b) here.
We’ve heard different things about not being able to advertise and needing to have people in your network. Let’s put it all in context. The rule doesn’t explicitly say that you need to know everybody. However, what it does say is the following:
There are two examples given on what constitutes solicitation. The first set of examples is an advertisement, article, notice, or similar media in newspapers, magazines, TV, or radio. This shows how lawmakers aren’t that up to date, as we revised this whole section much later. Who’s really advertising in the newspaper anymore? Actually, a lot of people do advertise their 506(c)s in newspapers successfully. But that’s not what we’re most interested in. Most people want to know about the web and social media.
Rule 502(c) is really saying that this is general advertising, but it’s not limited to just this. It’s really anything. I think any regulator would agree that if you put it on the web, social media, TikTok, YouTube, or whatever, we’re talking about something similar. So that is definitely general solicitation.
Let’s talk first about what we mean by putting this advertisement out there on the network and what you can and can’t do. General solicitation means we’re making a public announcement to the world, putting it out there where anybody could find out about it and come to us. What the SEC is trying to prevent here in Rule 506(b) is people putting together syndications and funds by broadcasting it out and bringing in non-accredited investors. The thought is that if you could put a net out there that is broadcast totally loud, but we’re able to bring in non-accredited investors, those non-accredited investors don’t have as much protection.
Compare this to a Regulation A offering. In a Regulation A offering, all the documents are put together and given to the SEC, who reviews them and makes sure there’s enough information for a non-accredited investor. That’s why it’s okay to advertise on a Regulation A offering and have non-accredited investors in the same one. But under 506(b), it would be completely abnormal.
It used to be that 506(c) didn’t exist. The only kind of way to market a Regulation D was with no solicitation of any kind. Allowing solicitation to occur under 506(c) is totally new and very different for us, whereas 506(b) has been there pretty much since the beginning.
Under 506(b), we’re trying to say that if you have this relationship, then you could do it. This brings us to the establishment of the relationship issue. If you can’t do a general advertisement, then there’s only one other conclusion: the investor had to have come to you through another means, meaning that you knew them. So you weren’t making a general solicitation; you were making a very specific solicitation.
This is definitely not to say that you can bring in investors who a friend of a friend of a friend knows because you’re not making a direct communication with them. That’s probably not okay. It doesn’t specifically say that in the rules, but once it starts getting reasonably removed from you, it starts looking more like some sort of general solicitation or an attempt to get around the rules.
The best possible advice I could give you is if you’re going to do a Regulation D Rule 506(b) offering, you only solicit to people that you already know. So it’s not a general solicitation; you go to the people you already have a pre-existing relationship with. It’s clear-cut; you’ve already got the relationship.
Where people start bending the rules is always, “Well, how do I have to know them?” I get this question a lot. “How do I have to know them in order to bring them into my offering? What about the friend of a friend? Can I do that?” And by the way, “I want to compensate my friend of a friend.” We’ll deal with that in the Finder section later. But for now, that’s probably not okay. It probably is outside of the rules because it starts looking like a general solicitation where if I’m relying on people that aren’t me to go and talk to other people, even if they’re not being compensated, that starts looking a lot like some sort of solicitation.
This brings us to our next example that the SEC gives us, or actually the lawmakers give us, on exactly what to do with the most common way that used to exist, and is still pretty common, to build the network and find investors. And that is a seminar or meeting.
What happened at first is people would say, “Okay, we cannot sell, we cannot do a solicitation, but here’s what we’re gonna do instead. I’m gonna put it out there, ‘Hey, come to my meeting.’ And we’re going to talk about real estate.” Now, people would show up at this meeting (I’m just using real estate as an example; it can be anything, investing in businesses, investing in notes, whatever it is). So people would show up to this meeting, and it wasn’t really about that. It was about, “Let me tell you about these investments that we’re working on, and you can come in that way.”
This rule, very specifically under Rule 502(c)(2), says, “Hold on a minute here. Whenever there is a seminar or a meeting where there’s been any kind of advertisement” – and I’m not gonna go through the exceptions because there are a few, but they’re actually very, very rare – “if there’s been this sort of solicitation of ‘Hey, come to my meeting,’ but at that meeting, I’m basically selling, that’s not okay.” That is a solicitation as well.
So these are the two ideas: A solicitation is no advertising, no doing this fake seminar thing in order to actually advertise. This is something that the SEC is very, very aware of, and this is something that every regulator knows is going on to a large extent. Solicitations are happening, and people are being sneaky and clever.
Now, there’s only so much that the SEC or any state can regulate it. But people are going to get caught, and people are going to have major, major penalties as a result of it. The odds of getting caught and that happening – I predict this, and it’s a prediction – I predict it’s going to go on the rise. I think as the economy changes, as people start investing more and more into alternative investments, and these things pick up even more than they are today – because I think that the alternative investment horizon is extremely bright. But that’s another topic for another day about why public markets are failing investors, but the private market, these alternative investments are going to do great, and they’re going to do a lot, and they’re going to make investors a lot of money. And they’re going to make syndicators and fund managers a lot of money in the very near future. I mean, they already do, but they will make even more.
What’s going to start happening is that hunger for investors, for non-accredited investors who can come into the offerings – people are just going to be more and more frustrated when they’re trying to put these deals together because they want more and more of those non-accredited investors. And it’s understandable that they do. I get people that we talk to every day who are putting deals together, and a lot of times, it’s “How can I make this work where I can have non-accredited investors? But I don’t have – but I can make this happen.”
And 99% of the time, these people are actually trying to just do a good thing. They’re trying to be the Robin Hood, like the stock trading platform of real estate or something, for the non-accredited investors, for the every person, for the people who don’t qualify for that. That’s very noble; it’s a great thing to do. It’s just not within the rules. And the regulators know this.
The whole point of the rule is to protect those non-accredited investors, not from these people who are trying to do a good thing, but from the people who are unscrupulous and will take advantage of them. So how can the state regulators and the SEC monitor this more? Well, there’s going to be a lot more investigations, and there’s going to be a lot more things that start happening as people start digging deeper into what’s actually going on here.
Now, I’ve seen this happen firsthand. I have a client who was putting together a Rule 506(b) offering. Before they hired me, they had put together a Rule 506(c) offering and put it out there as well. Now, that offering actually never happened, and actually, both offerings – we changed everything radically and restructured it and put it forward because there were technical problems about the assets that they wanted to actually acquire. They weren’t available; they were real estate assets. And it turned out that they just didn’t want to go through that and wanted to repackage it. So nothing happened.
But under that Rule 506(c) offer, they were testing the waters. They put some advertisements out there. Well, one of the states, one of the 50 states, a state regulator had seen that ad. And they were concerned about it. So they thought maybe they were advertising a Rule 506(b) offering. So they wrote my client a letter and said, “Please tell us everything you can about this offering.”
Now, this wasn’t the offering that I did for them. This was actually a 506(c) offering that was actually done, but they didn’t have an attorney at the time who knew to put that sort of thing, make it very clear that it’s a Rule 506(c) offering, only accredited investors, the independent verification, blah, blah, blah. So they didn’t know. So the regulators didn’t know, but the point is that they were watching.
And they reached out to my client and said, “Okay, what about this? And tell us about every other offer you have going on.” Because then as they did an investigation, they started hearing about the other offer that I wrote, the 506(b) offer. I don’t know how it came about – oh, I know how it came about. Because we did a – we filed the Form D on it ahead of time. So they saw that. They looked up all the deals that my client had done, they saw that there was also this Rule 506(b) offer. And they wanted to know about what went on. Who are they? How many investors did they have? What states were they coming from? What was the money? Why didn’t they receive notice?
Well, the fact is, no sale had occurred. So it was okay that nothing happened. But they were watching. And I think they’re going to be watching more and more. You see a lot of advertisements of these offers that are out there. And it’s kind of hard to figure out whether it’s Rule 506(c) or 506(b). But they may make mention of a state where “we’ve got this great multifamily property in Texas,” “Hey, we’re going to be doing oil and gas in Louisiana” or wherever, in North Dakota. The states are also looking and monitoring it because they’re concerned that their citizens are going to be taken advantage of.
So they are going to be watching, and they’re going to increase the level of investigation. Now, the SEC today doesn’t proactively investigate until there’s been a lawsuit. But they could change their mind; they could decide to be more proactive about it. And they may. Certainly, the states can do whatever the states want in terms of investigating. They have a right to not only make sure that they get noticed but also to investigate to see what’s going on. And I predict that it’s going to happen more and more.
One thing I’ve also noticed is that people are putting together what they’re saying is, “Oh, we’re testing the waters and plan on doing a Regulation A offering,” where they’re not trying to do a Regulation A offering. As soon as you submit to them, “Tell me more about this investment,” because it says specifically for non-accredited investors, you’re going to notice that, “Oh, this – we’re actually not going to be able to do the Regulation A offering. But we are doing a Regulation D Rule 506(b) offering.” That’s not going to fly. No regulator is going to let that slip. I predict that all the people that are doing that are also going to get munched, and rightly so. They’re trying to skirt the rules.
Again, just like I discussed in the first video in this series, regulators are very smart people. They’re great lawyers, they really are. And their job, their mission in life, is to protect the public. Don’t try and get clever; just follow the rules, and everything’s fine. Their rules are wide enough for everybody to be able to raise as much money to do whatever projects they want to do. The rules are there to protect the public. And by complying with the rules, we stay out of trouble with the SEC and the states. We’re in compliance, we’re doing better for our investors anyway, because we’re complying with those rules.
I mean, how awful would it be if one of your investors loved what you were doing? They just loved it. It was so amazing. They called you every week. They were just like, “Oh, you’re the greatest person ever.” But someone else was unhappy. And then the SEC stomped on them because you did something that was wrong. And now the person who loved you – they’re out also. Their whole deal just fell completely apart suddenly, and they lost. That’s why investors get hurt by this as well.
So I hope this helps. That is about solicitation. So solicitation of Regulation D Rule 506(b) offers – it’s happening out there, but it doesn’t need to, and it shouldn’t. It is against the rules. And when we say no solicitation, bottom line is no solicitation. That’s all the regulators are asking for: to follow that very simple rule that you follow Rule 502(c) of Regulation D Rule 506(b).
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. If we can help you with your Regulation D Rule 506(b) offering or your 506(c) offering, feel free to give us a call, and let’s talk about your project so we can make sure that you are in compliance and that ultimately you’re successful in raising the money and bringing what you want people to invest in out to the public so that people can invest, make money, you make money, everybody wins.