By Yoan Valiente, Founder & CEO · Updated · Part of the CRE investment glossary
How Rule 506(b) works
Section 4(a)(2) of the Securities Act exempts transactions by an issuer that do not involve a public offering, but it does not say exactly where a private offering ends. Rule 506(b) of Regulation D is the objective safe harbor. If an offering meets its conditions, it qualifies under Section 4(a)(2) without the issuer having to argue the point facts-by-facts.
The SEC describes the trade this way: an issuer can sell to an unlimited number of accredited investors and raise an unlimited amount, as long as it does not market the securities through general solicitation or advertising. That is why 506(b) fits a sponsor who raises from people it already knows.
The conditions in the rule
Rule 506(b) applies the general conditions of Rules 501 and 502 and adds two limits of its own:
- No general solicitation or general advertising to market the securities.
- No more than 35 purchasers who are not accredited investors in any 90-calendar-day period, counted under Rule 501(e).
- Each non-accredited purchaser, alone or with a purchaser representative, must have enough knowledge and experience in financial and business matters to evaluate the merits and risks of the investment, or the issuer must reasonably believe so before the sale.
- If any non-accredited investor participates, the issuer must give that investor the disclosure and financial statement information the rule specifies, and answer questions. Information given to accredited investors must also be made available to them.
Accredited investors and self-certification
Rule 506(b) does not require the issuer to verify accredited status with documents. The issuer needs a reasonable belief that each purchaser is accredited, which sponsors commonly document with an investor questionnaire. Rule 506(c), which allows advertising, is different: it requires reasonable steps to verify.
Admitting even one non-accredited investor changes the work: the disclosure package grows and the sponsor takes on the sophistication question. Many sponsors keep a 506(b) offering to accredited investors for that reason, but that is a choice, not a requirement of the rule.
Form D, restricted securities and state notices
An issuer relying on Rule 506 files a Form D notice with the SEC within 15 days after the first sale, which is the date the first investor is irrevocably contractually committed. The SEC charges no fee for Form D. Securities sold under 506(b) are restricted securities, so investors cannot freely resell them.
Rule 506 securities are covered securities under Section 18 of the Securities Act, so states cannot require registration of the offering, but they keep the power to require notice filings. State requirements are outside this page; ask counsel which states apply to your investors.
Common mistakes
The failures that matter most with 506(b) are about marketing, not paperwork:
- Posting the deal publicly, in a social post, an open webinar or a public deal page, which is general solicitation.
- Treating a new relationship formed only to sell the deal as a pre-existing relationship.
- Letting a non-accredited investor in without the required disclosure.
- Missing the Form D deadline because the first-sale date was read as the closing date.
Where to go next
This page defines the rule. To choose between 506(b) and 506(c) for a real offering, read the comparison guide, which covers the marketing and verification trade-off. This page is general information, not legal advice. Ask securities counsel before you rely on an exemption.
Primary sources
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.