Can you form a substantive, pre-existing relationship in fewer than 30 days? For Internet platforms offering private placements in reliance on Rule 506(b) of Regulation D, the answer is "yes." Based on an SEC no-action letter issued to Citizen VC, Inc. ("Citizen VC") on August 6, 2015, and a series of compliance and disclosure interpretations ("C&DIs") issued on the same date by the SEC Division of Corporation Finance, an Internet platform may engage in "speed-dating" with prospective investors it meets online - so long as the platform asks probing questions. In essence, the SEC is backing off a time-based approach and moving toward a more qualitative approach.
Despite the introduction of Rule 506(c), most issuers and agents continue to make traditional private placements in reliance on Rule 506(b), a condition of which is that the offering is not made through general solicitation or advertising.1 The SEC has long recognized that there is no general solicitation where there is a substantive, pre-existing relationship between the issuer or its agent, and the prospective investor. However, the process by which an Internet platform can develop this type of relationship with a prospective investor who lands on the platform's website has been far from clear.
Many Internet platforms seeking to avoid engaging in a "general solicitation" in contravention of Rule 506(b) have been relying on the "check the accredited investor box and wait 30 days" approach to creating a substantive pre-existing relationship with potential investors. Until last week, the most recent SEC guidance on the establishment of this type of relationship in an online transaction was from the Lamp Technologies, Inc. No-Action Letter (May 29, 1997). In reliance on Lamp, Internet platforms making 506(b) offerings generally create a generic home page about the issuer or the intermediary, but require a password to access parts of the website containing descriptions of specific investment opportunities. In order to obtain a password to access the full site and view investment opportunities, a potential investor is required to complete an online questionnaire in which the potential investor certifies that he/she meets the accredited investor requirements. Assuming satisfactory completion of the questionnaire, and after a 30-day waiting period, the potential investor is permitted to make investments through the platform.
In order to obtain some much-needed clarity in this area, Citizen VC requested that the SEC staff concur with Citizen VC's conclusion that the policies and procedures discussed in its no-action request letter will be sufficient to create the necessary substantive pre-existing relationship between Citizen VC and prospective investors. Citizen VC is the owner and administrator of an online venture capital investment platform through which it aggregates investments of prospective investors in special-purpose vehicles that invest in seed, early-stage, emerging growth, and late-stage private companies. Citizen VC follows the standard model of a generic Web page with an online questionnaire in which the potential investor certifies that he/she meets the accredited investor requirements.
In its request letter, Citizen VC represented that during the "relationship establishment period," following the receipt of the questionnaire, it undertakes various additional actions to connect with the prospective investor and collect information it deems sufficient to evaluate the prospective investor's sophistication, its financial circumstances, and its ability to understand the nature and risks related to an investment in the privately offered securities. The actions include:
In its request for no-action relief, Citizen VC represented that it will admit the prospective investor to the password-protected section of its platform only after Citizen VC is (a) satisfied that the prospective investor has sufficient knowledge and experience in financial and business matters to enable it to evaluate the merits and risks of the investment opportunities on the platform, and (b) has taken all reasonable steps it believes necessary to create a substantive relationship with the prospective investor.
In its response to Citizen VC, the SEC noted that there is no specific duration of time or particular short-form accreditation questionnaire that can be relied upon solely to create a substantive relationship. Rather, "the quality of the relationship between an issuer (or its agent) and an investor is the most important factor in determining whether a 'substantive' relationship exists." This point is hammered home in the SEC's CD&Is, which confirm that a "substantive" relationship is "one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree's financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person's financial circumstances or sophistication is not sufficient to form a 'substantive' relationship." See Securities Act Rules, CD&I Question 256.31.
For platforms eager to keep the momentum with potential investors they meet online, the SEC's recognition that a 30-day waiting period is not necessary will be welcome news. At the same time, many platforms will have to step up their game and re-evaluate their "getting to know you" procedures. While the SEC did not specifically endorse Citizen VC's approach, it is clear that Internet platforms will need to (a) implement policies and procedures to enable them to obtain sufficient information to evaluate a prospective investor's financial circumstances and sophistication, and (b) thoroughly evaluate the information they gather in order to ensure that the Internet platform's offerings are suitable for the investor. In establishing best practices for developing a "quality" relationship, keep in mind that, as with actual online dating, it's advisable to have some offline interactions with the object of your affections before making a commitment.
--- While Rule 506(c) of Regulation D permits issuers to engage in general solicitation and advertising, many issuers and intermediaries have been reluctant to use this new rule, due to the heightened verification requirements for accredited investors and the perception that the SEC is scrutinizing these offerings closely, and because of lingering concern that the SEC will place additional restrictions on the use of such offerings, for example, by requiring multiple Form D filings.
On January 30, Michael Rave and Richard Leu will be speaking at Bank Director's annual conference, Acquire or Be Acquired, in Phoenix, Arizona.
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