Here’s the difference between the two rules – and how it affects you
The enactment of the JOBS Act in 2012 and the implementation of the new law by the SEC (which is still in progress) have shifted the regulatory landscape for private securities offerings. Even within the equity crowdfunding industry, different platforms rely upon different regulations, so it’s easy to understand how some investors can become confused. This piece is intended to discuss the regulations that are currently in place, and to help explain how PeerRealty offerings fit into that regulatory framework.
The Securities Act of 1933 was the first major piece of federal legislation regulating securities offerings. The act laid out a series of disclosure requirements for registered public offerings. For the purpose of private securities offerings, however, Sec. 4(a)(2) of the Securities Act stated that those requirements did not apply to “transactions by an issuer not involving any public offering.”
As crowdfunding attorney Mark Roderick notes, the “putting-the-rabbit-in-the-hat nature of that language” eventually required more clarity. In 1982, the SEC attempted to create that clarity by issuing Regulation D. Regulation D laid out the rules under which issuers could privately offer and sell securities while remaining exempt from the registration requirements of the Securities Act. Rule 506(b) of Regulation D created a “safe harbor” for these issuers – under 506(b), they can raise an unlimited amount of money, provided that they meet the following requirements:
- Most significantly, the issuer or broker cannot use general solicitation or advertising to market the securities. They can market the securities to existing customers with whom they have already established a meaningful relationship, but cannot actively solicit new investors.
- The issuer can sell securities to an unlimited number of “accredited investors” along with up to 35 non-accredited investors who meet certain sophistication requirements, provided that the non-accredited investors receive disclosure documents “that are generally the same as those used in registered offerings.”
- However, 506(b) allows investors to self-certify as accredited investors via a questionnaire.
When crowdfunding (raising funds for a project or venture from a large number of people via the internet) became a widely used fundraising technique in the last decade, proponents suggested that equity crowdfunding would be a natural outgrowth of the practice. Since equity crowdfunding involved commercial enterprises, it was subject to existing securities regulations, including Regulation D. The Rule 506(b) ban on general solicitation and advertising appeared to bar private equity crowdfunding offerings, though, while the huge costs required to comply with regulatory requirements for public offerings made this route economically unfeasible for virtually all equity crowdfunding platforms.
Given that neither the internet nor crowdfunding even existed when Regulation D was issued in 1982, lawmakers sought to modernize federal securities law while still maintaining the important investor protections contained in existing regulations. The result was the JOBS Act, which was passed into law in 2012. Title II of the JOBS Act directed the SEC to lift the ban on general solicitation, provided that all the investors in the offering are accredited.
After over a year of rulemaking, the SEC finally implemented Title II of the Jobs Act by amending Regulation D. The amendment added a new rule, Rule 506(c), to Regulation D. Rule 506(c) provides that:
- As Congress directed, issuers may use general solicitation or advertising to market their offerings to investors.
- Unlike Rule 506(b), which allows for up to 35 non-accredited investors, Rule 506(c) offerings may only be sold to accredited investors.
- The issuer has taken “reasonable steps to verify” that all purchasers are accredited investors.
This last provision again differs from Rule 506(b), which allowed investors to “self-certify” their accreditation status. The SEC, recognizing the need for flexibility, declined to specify an exclusive list of verification methods constituting “reasonable steps.” Instead, Rule 506(c) lists several “non-exclusive” methods, which include reviewing documentation like W-2s, tax returns, bank and brokerage statements, and credit reports. Alternately, certain licensed professionals (broker-dealers, registered investment advisors, attorneys, or accountants) may provide written confirmation that they have taken reasonable steps to determine that a purchaser is an accredited investor.
So what does all of this mean for investors on the PeerRealty platform? As you may have guessed, PeerRealty operates under Rule 506(c). We obviously use general solicitation and advertising, but our offerings are currently limited to accredited investors. We take several steps to verify that all investors are accredited, one of which is asking investors to upload documentation prior to investing. We also use Crowdentials, an established investor verification platform, to review and verify this information. Investors also have the option of completing the verification forms on the platform and automatically sending the forms to their own lawyer or accountant (or other licensed professional) to provide written confirmation of their accreditation status. In most cases, the verification process can be completed within 24-48 hours.
We hope this helps explain the need for investor accreditation verification. At PeerRealty, we’re dedicated to compliance. We work with experienced compliance and crowdfunding attorneys, and our founder and CEO is a former attorney himself. We feel this will help us make our way through the shifting regulatory landscape. There’s no question that real estate crowdfunding is a relatively new way of investing, but some traditional rules still apply. Investors should focus on the platforms that have the clearest understanding of SEC regulations and that are the most transparent in explaining what they’re doing to maintain compliance at all times.