SEC COMPLIANCE

Regulation D 506(b) vs 506(c): Which One Fits

By Baruch Mackliff, the Capital Commander · PRBE Capital

Topic: SEC compliance for a private raise

Almost every private raise in the United States happens under one of two rules, and they are usually described as though the difference were a formality. It is not. The choice between them decides who you are allowed to talk to, what you have to collect from every person who wires money, and what a lawyer will ask for first if the company later disappoints somebody.

Both rules live inside Regulation D. Both are safe harbours for the private placement exemption, which means an offering meeting the conditions is deemed not to be a public offering. Neither carries a ceiling on how much you may raise. Both produce restricted securities, both require a Form D, both are subject to the bad-actor disqualification provisions, and both are treated as covered securities, so states may charge a notice filing fee but may not review the merits of the deal.

Everything else about them differs.

Rule 506(b): quiet, and cheaper to administer

The defining condition of 506(b) is negative. You may not use general solicitation or general advertising to find investors. No public posts about the round. No cold email campaign to a purchased list. No open web page where a stranger can commit money. No pitch from a stage in front of an audience anyone could have bought a ticket to.

What you may do is approach people you already know, through relationships that existed before this offering was conceived and that are substantive enough that you know something about the person's financial circumstances and sophistication. Securities lawyers call that a pre-existing substantive relationship, and it is the single most misunderstood idea in private fundraising. Pre-existing means the relationship predates the offering. Substantive means it is more than a business card and a handshake. Somebody who completed a web form on your site last week is neither.

In exchange for that restraint, 506(b) gives you two things.

• Accredited status may rest on a reasonable belief. In practice that means a subscription questionnaire in which the investor states which category they fall into, plus whatever else you have learned in the course of the relationship. You are not obliged to audit them. You are obliged to actually form a belief: a questionnaire nobody read, or a box ticked by a person whose circumstances plainly contradict it, is not a reasonable belief.
• A limited number of purchasers who are not accredited may participate. The rule caps that number, so confirm the current figure with securities counsel rather than assuming it. Each of those purchasers must be sophisticated, meaning they hold enough knowledge and experience in financial and business matters to weigh the merits and risks, alone or with a purchaser representative.

That second allowance is a trap dressed as flexibility. The moment one non-accredited purchaser is admitted, a full disclosure obligation attaches to the offering. You must deliver specified information to that purchaser, the depth of it scaling with the size of the offering, and at certain sizes that includes financial statements prepared to a standard the rule specifies, with an audit required in some cases. You must also give non-accredited purchasers a genuine opportunity to put questions to management and receive answers.

So admitting one friend who is not accredited into an otherwise accredited round can convert a straightforward closing into a full disclosure document and an audit. Many issuers decide a single small subscription is not worth that and restrict the round to accredited investors. That is a legitimate and common choice, and it is a budget decision as much as a legal one.

Rule 506(c): advertise, and prove it

Rule 506(c) inverts the arrangement. You may use general solicitation and general advertising freely. Post the round publicly, run ads, speak at an open event, put a subscription page on the open web and let strangers find it.

The price is two conditions with no equivalent in 506(b).

• Every purchaser must actually be accredited. Not most of them, not the ones who came in early. Every single one. There is no allowance for sophisticated non-accredited purchasers at all.
• The issuer must take reasonable steps to confirm that status. This is an objective requirement. It is not satisfied by a statement from the investor, however sincere, and it is not satisfied by a box ticked on a web page.

The rule sets a principles-based standard and then supplies a non-exclusive list of methods deemed to satisfy it for natural persons. The ones used in practice:

• The income route. Review of the investor's tax filings reporting income for the two most recent years, together with a written statement that they reasonably expect to reach the qualifying income level in the current year.
• The net worth route. Review of specified documentation of assets and of liabilities, each dated within a recent window the rule defines, together with a written statement that all liabilities have been disclosed. Have counsel tell you exactly which documents the rule accepts on each side of that calculation, because the liabilities side is where issuers most often go wrong.
• Third-party confirmation. Written confirmation from a registered broker-dealer, a registered investment adviser, a licensed attorney or a certified public accountant that the professional has taken reasonable steps within a recent period and determined the investor is accredited. This is the route most issuers choose, because it keeps the investor's private financial papers out of the company's files entirely.
• Existing investors and prior work. There are accommodations for an investor who bought in an earlier offering by the same issuer, and for an investor already confirmed within a defined look-back period who provides a written statement that they remain accredited. The look-back and its conditions are specific. Confirm them.

Two points issuers get wrong here. First, the listed methods are safe harbours, not the only permissible approaches, but a company using something outside the list carries the burden of showing its steps were reasonable. Second, whatever method you use, keep the evidence. The exemption is not something you assert later from memory. It is something you document at the time and store, because the question always arrives after an investment has gone badly, never before.

What is identical in both

• Form D. A notice filing is due with the Commission within fifteen calendar days of the first sale. It is short, it is electronic, and missing it does not by itself destroy the exemption, but it is public, it is checked, and states hang their own filings on it.
• State notice filings. Securities sold under either rule are covered securities, so a state may not review the deal, but most states still require a notice filing and a fee on their own deadlines, in every state where an investor resides. Those deadlines are not the federal one.
• Restricted securities. Investors receive restricted stock. It carries a legend, the issuer must exercise reasonable care to prevent a resale that would breach the rules, and a holder waits out a holding period before an exempt resale route opens. Tell investors that in plain language before they subscribe, not after.
• Bad-actor disqualification. Certain past events involving the issuer, its officers, its directors, significant shareholders and anyone paid to solicit investors will disqualify the offering from either rule. The check runs on people, not on the company alone, and it runs before the raise, not during the closing.
• Antifraud liability. Neither rule exempts anyone from the antifraud provisions. An exemption from registration is not an exemption from telling the truth.

Choosing between them

The decision is almost always settled by one question: can you complete the round from people you already know?

If the answer is yes, 506(b) is simpler and costs less to administer. There is no confirmation programme to run, no third-party letters to chase, and investors are not asked to hand over financial papers, which some of them will refuse to do. Your discipline requirement is silence. You have to be genuinely willing not to talk about the round in public.

If the answer is no, and you need to reach people who do not know you, 506(c) is the rule that permits it. Budget for the confirmation work from the start rather than discovering it at the first closing.

What you cannot do is run 506(b) and quietly market as though you were running 506(c). That is the most common serious failure in this area, and it nearly always happens by accident: a founder posts about the raise, an adviser forwards the deck to a list, the company appears on a public marketing page, a podcast episode mentions the round is open. Any one of those can amount to general solicitation, and general solicitation is incompatible with 506(b).

There is also the question of switching. Moving an offering from one rule to the other is governed by integration principles modernised in recent years, with safe harbours including one based on a gap in time between offerings. The practical asymmetry is the part to carry: moving from a quiet offering to a solicited one is the manageable direction. Moving the other way is very hard, because you cannot retract a public communication that has already gone out.

What happens when the exemption fails

Worth stating without softening, because it is why these rules are worth following precisely.

If the exemption is lost, the offering becomes an unregistered public offering of securities. Purchasers acquire a right to rescind, meaning they may demand their money back with interest, and that right does not depend on anyone having behaved dishonestly or on the investment having performed badly. It depends only on the sale having been neither registered nor exempt. State regulators may act on their own authority in parallel.

Rescission rights across a full round are an existential problem for a small company, and they surface at the worst possible moment: during diligence for the next round, during a sale of the company, or when a disappointed investor consults a lawyer. Fixing them afterwards is expensive and public. Getting the rule right at the start costs a fraction of that.

One further caution. Anyone paid a commission or a success fee for introducing investors may be acting as a broker, and brokers must be registered. Paying an unregistered finder is its own violation, with its own consequences for the offering, and the arrangement does not become acceptable because the parties wrote consulting fee on the invoice.

A short checklist before the first wire

Decide the rule in writing and tell everyone who speaks for the company which one you are under. Run the bad-actor check on every officer, director, significant holder and anyone being paid to raise. Have the subscription documents drafted for the rule you actually chose, because a 506(c) package and a 506(b) package are not the same document. Fix the process for confirming investor status and name the person responsible for running it. Calendar the Form D deadline from the first sale, not from the closing. Then collect the state filings as investors come in, rather than reconstructing residences afterwards from a spreadsheet.

PRBE Capital works with owners at exactly the point where this gets decided: mapping where the money is realistically going to come from, choosing the rule that matches that answer, and making sure the subscription documents, the investor-status process and the notice filings are in place before the first wire rather than after. The first conversation costs nothing and promises no approval.

This is an explanation of how these two exemptions are structured, not legal, financial or securities advice; the purchaser limits, accepted methods, look-back periods and filing deadlines change over time, and the version that governs your offering is the one in effect when you sell, so confirm every current requirement with securities counsel before relying on it.

Common questions

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

Rule 506(b) forbids general solicitation and advertising, but lets you rely on a reasonable belief that an investor is accredited and permits a small capped number of sophisticated non-accredited purchasers. Rule 506(c) permits open advertising, but every purchaser must be accredited and the issuer must take reasonable steps to confirm it with documentation rather than a statement from the investor.

Can I advertise my Reg D offering on social media?

Only under Rule 506(c). A public post about an open round is general solicitation, and general solicitation is incompatible with Rule 506(b). This is the most common way a quiet offering loses its exemption by accident, and it usually happens through a founder's own social account or a forwarded deck.

What counts as reasonable steps to confirm an accredited investor?

The rule sets an objective standard and supplies a non-exclusive list of accepted methods, including review of recent tax filings for the income test, review of specified asset and liability documentation for the net worth test, and written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney or certified public accountant. A ticked box or a self-certification is not enough. Keep the evidence on file, because the question arrives long after the money does.

Can non-accredited investors invest in a 506(b) offering?

Yes, up to the number the rule caps, and each of them must be sophisticated enough to weigh the merits and risks, alone or with a purchaser representative. Admitting even one triggers a substantial disclosure obligation to those purchasers, scaling with the offering size and requiring financial statements at certain levels. Many issuers restrict the round to accredited investors rather than take that on.

What is a pre-existing substantive relationship?

It is the basis on which a 506(b) issuer may approach an investor without soliciting the public. Pre-existing means the relationship existed before this offering was contemplated. Substantive means it is deep enough that you know something real about that person's financial circumstances and sophistication. A web form completed last week satisfies neither half.

Do I have to file anything after a Regulation D raise?

Yes. A Form D notice is due with the Commission within fifteen calendar days of the first sale, and most states require their own notice filing and fee, on their own deadlines, wherever an investor resides. The federal filing is short, but states often condition their filings on it, so missing it creates a cascade.

What happens if I break the general solicitation rule?

The exemption can be lost, which turns the round into an unregistered public offering. Purchasers then have a right of rescission, meaning they may demand their money back with interest regardless of whether anyone behaved dishonestly, and state regulators may act separately. It normally surfaces during diligence for the next round or a sale of the company, which is the worst possible moment to find it.