10thJanuaryThe 7 Not-So-Obvious Implications of GeneralSolicitation Offerings

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The ability to engage in general advertising in Rule 506(c) offerings should change the way many issuers raise money. Issuers now have the opportunity to reach potential investors beyond their networks, friends and family, and theconnections that their broker-dealers have. Issuers can now take advantage of communication platforms and marketingtools such as the internet, newspapers, television and radio. Using general solicitation, however, will create somecorollary implications that I address below.

(1) Privacy Concerns

The new requirement that issuers must take “reasonable steps to verify” accredited investor status raises privacyconcerns. Issuers who use general advertisement will have to request private financial information from potentialinvestors, or will have to find other acceptable ways to demonstrate and document that each investor qualifies as anaccredited investor. Asking for this information, may raise privacy and security concerns and may deter potentialinvestors from investing in the offering.

(2) Due Diligence on Covered Persons and Disqualifying Events

In light of the new “bad actor” disqualification rules and the exception for issuers who take reasonable care in the duediligence process, issuers will need to implement due diligence and verification procedures to determine whether theissuer, any placement agent, or any other covered person is, or during the applicable look-back period was, subject toa “disqualifying event.” Registered broker-dealer firms and their employees who have been subject to certaindisqualifying events will not be able to assist with Rule 506 offerings without an SEC waiver. Obtaining questionnairesfrom directors and officers and 20% or greater owners should be considered by issuers. And requiring placementagents and other covered persons to provide appropriate contractual representations should also be considered. Inaddition, further due diligence may be appropriate such as, judgment searches and review of broker-dealer compliancerecords.

Employment Agreements. Many employment agreements with executive officers contain a “for cause” provision thatallows the Company to terminate such executive. These executive employment agreements typically haveconsequences for a termination for cause. While the definition of “cause” often contemplates a felony conviction or otheracts of moral turpitude, an act of disqualification event under Rule 506(d) may not fit within the definition. Thus, it isprudent to consider whether a disqualification event under Rule 506(d) for bad actors should be added to the definitionof “cause.” Otherwise, the issuer may be stuck in the unenviable positions of having to determine whether to terminatean executive without cause or being unable to rely on Rule 506 when raising money.

Directors who become bad actors. The bad actor rule under Rule 506(d) prohibits a company from using Rule 506 if anyof its directors is involved in any of the disqualifying events listed in the rule. The issue to consider with this rule is thatdirectors are elected by the shareholders, not by the Company. In other words, company management is not always incontrol of who gets elected as a director. In the case of new directors, one solution may include asking potentialdirectors to disclose any disqualifying events in hopes that this will reduce the likelihood of this person being elected asa director. However, there remains an issue with directors who engage in a disqualifying event while on the board. For

both scenarios, issuers should consider amending their articles or bylaws to include director qualification provisions thatprohibit any disqualifying events under 506(d) and these disqualification requirements should be a continuing obligation,such that the director must meet the requirements at all times while serving as a director.

(3) Brand Consequences

When using general solicitation for an offering, issuers should consider how the disclosure information provided in anyadvertisement will impact the Company’s brand. Additionally, issuers must consider the information on its website inadvance of and during a private offering using general solicitation, because this information will be deemed a part of thegeneral solicitation. Finally, issuers should be prepared to address any inaccurate reporting from the media that isbased on the publicly-disclosed information.

(4) Failure to Raise Enough Money

Issuers should consider the consequences of failure to raise all the money they need in an offering using generalsolicitation under Rule 506(c). Remember that a Rule 506(c) offering using general solicitation can only be sold toaccredited investors. If the issuer later determines that it needs to sell to unaccredited investors after commencing aRule 506(c) general solicitation offering, the issuer may be left without any exemption from the registration requirementsof the Securities Act. If an issuer needs to make a follow-on offering to make up the difference, it may be a long timebefore the issuer is able to use another private placement. Further, early stage issuers often need to raise capitalthrough private placements regularly and thus must consider possible integration of offerings conducted within a 6-monthperiod.

(5) Anti-Fraud Rules Apply to General Solicitations

This may seem obvious, but it’s worth pointing out that the anti- fraud rules under the securities laws for making materialmisrepresentations or omissions in connection with securities offerings apply to general solicitation offerings under Rule506(c). Issuers should carefully consider the form, content, and distribution of all advertising and solicitation materials. This includes any materials communicated using the internet and social media platforms. Issuers should expect theSEC to scrutinize these communications.

(6) No Fallback Exemption

The exemption from registration to offerings made under Rule 506 are authorized by Section 4(a)(2) of the Securities Actwhich is an exemption for non-public offerings. In the past issuers who were unable to satisfy the requirements of theRule 506 safe harbor could seek to qualify under the Section 4(a)(2) statutory exemption for private offerings. However,this fallback position is not available for general solicitation offerings under Rule 506(c).

(7) Intellectual Property Issues

Issuers should consider the need to protect trade secrets and other intellectual property while disclosing enough

information for investors to make an investment decision. Especially in light of the America Invents Act, which created atotal shift in the patent regime from the “first to invent” rule to a “first to file” rule. In the past, private placements were to aselected group of individuals who could more easily be bound by non-disclosure agreements (NDA). With a generalsolicitation offering it may be more difficult to ensure that everyone is bound by an NDA.

Bottom Line: Using general solicitation in a Rule 506(c) offering will come at a price. The challenge will be to considerall of these consequences against the benefits of general solicitation to determine whether a Rule 506(c) offering is thebest route under the particular circumstances.