Rule 506(c)

Rule 506(c) represents a major change in how private placementA securities offering that is exempt from public registration requirements and typically limited to accredited or sophisticated investors. offerings work. The Jumpstart Our Business Startups (JOBS Act) of 2012 created this rule to modernize how companies raise capital while still protecting investors. This exemption lets hedge funds and other companies publicly market their investment opportunities through channels that were previously banned under federal securities law. This change has fundamentally transformed how private funds can advertise themselves.

Rule 506(c) came from Section 201 of the JOBS Act, which President Obama signed on April 5, 2012. The SEC created this rule by changing Regulation D Regulation D Regulation D provides exemptions from SEC registration requirements for private placements of securities, with hedge funds typically relying on Rule 506(b) for traditional private offerings or Rule 506(c) for offerings involving general solicitation. to add Rule 506(c). Now managers can advertise their funds publicly, but they must take reasonable steps to verify that investors actually qualify as "accredited investor Accredited investor An accredited investor refers to an individual or entity that meets specific financial thresholds set by securities regulations, qualifying them to invest in unregistered securities offerings such as hedge funds, with standards including minimum income or net worth requirements. "—they can't just take the investor's word for it anymore.

Rule 506 has two different parts: Rule 506(b) Rule 506(b) Rule 506(b) is a securities law exemption that allows private companies to raise unlimited capital without SEC registration, provided they don't advertise publicly and limit sales to accredited investors plus up to 35 sophisticated non-accredited investors. and Rule 506(c). Under Rule 506(c), offerings don't need to register with the SEC if all investors are accredited investors and the company has taken reasonable steps to verify each investor's status. Unlike Rule 506(b), Rule 506(c) allows companies to advertise and market their offerings publicly.

Rule 506(c) offerings are specifically allowed to use general solicitationPublic communications or advertisements directed to potential investors, prohibited under Rule 506(b) but permitted under Rule 506(c). and general advertisingPublic marketing communications used to promote investment opportunities, restricted under certain private placement exemptions., which other Regulation D offerings cannot do. This means companies can engage in broad marketing activities. They can post information on websites, place ads in media, hold seminars, and use other public communications. However, they must still follow the verification requirements for investor status.

The SEC designed Rule 506(c)'s verification rules using a flexible approach rather than strict, detailed requirements. Companies must make an objective decision that their verification steps are reasonable. They should consider factors like what type of investors they're targeting, what information they have about those investors, and the specific details of their offering.

On March 12, 2025, the SEC issued important new guidance that made Rule 506(c) verification much easier. This guidance established that companies can meet verification requirements by setting minimum investment amountsThe smallest dollar amount that a fund will accept from new investors, typically set to limit administrative costs. along with written statements from investors. They no longer need to review extensive financial documents in most cases.

Under the 2025 guidance, companies can reasonably conclude they've done adequate verification when they require minimum investments of at least $200,000 for individuals or $1 million for legal entities. Investors must also provide written statements confirming they qualify as accredited investors and that they're not using borrowed money specifically to make this investment.

The SEC provides both traditional and simplified ways to verify investor status. Traditional methods include reviewing tax forms to confirm income levels, examining recent financial statements and credit reports to verify net worth, or getting written confirmations from registered professionals like brokers, attorneys, or accountants.

The simplified approach from March 2025 allows companies to rely on substantial minimum investment amounts as evidence that investors are accredited. This significantly reduces paperwork and administrative work while still meeting regulatory requirements. This development addresses the main obstacle that historically prevented many companies from using Rule 506(c).

Companies using Rule 506(c) must ensure investors actually qualify as accredited, not just that they completed the verification process correctly. The SEC emphasizes that reasonable verification steps are required regardless of whether investors truly qualify. This creates higher compliance obligationsLegal and regulatory requirements that organizations must meet to ensure adherence to applicable laws and industry standards. compared to Rule 506(b) offerings.

The verification requirement applies each time an investor makes a purchase. Companies must also consider factors like existing relationships with investors and the sophistication level implied by minimum investment requirements when designing their verification procedures.

Following the March 2025 guidance, industry experts expect many more companies to use Rule 506(c). Historically, only about 4% of hedge fund offerings used Rule 506(c) instead of 506(b) because verification was so burdensome. The simplified verification procedures should change this balance significantly.

However, managers should know that Rule 506(c) offerings may still receive more regulatory attention. The conventional wisdom suggests that conducting public advertising may increase the likelihood of regulatory examination and result in more thorough review of marketing processes, procedures, and materials compared to traditional private offerings.

Modern hedge fund managers now face a completely different decision when choosing between Rule 506(b) and Rule 506(c). The March 2025 guidance essentially eliminates the main compliance burden that previously discouraged Rule 506(c) use, while keeping the significant marketing advantages of being able to advertise publicly.

Managers must still consider international offering implications, since advertising in the U.S. may affect their offshore transactionA securities transaction that occurs outside the United States, with offers not made to persons located within the United States. strategies. Additionally, state-level notice filing requirements still apply, and managers should ensure they comply with applicable state regulations despite federal preemptionLegal principle that allows federal securities law exemptions to override state registration and merit review requirements, though states may still impose notice filing and fee requirements. of state substantive regulation.