A "TIC"ING TIME BOMB: RULE 506 MEETS SECTION 1031

Fordham Journal of Corporate & Financial Law, 2007 by Whitman, Elizabeth Ayres

Prohibition of general solicitation and general advertising is required for a Rule 506 offering to qualify as a private placement under Section 4(2) of the 1933 Act. Rule 502(c), which sets forth the prohibition on general solicitation and general advertising provides:

[N]either the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

(1) Any advertisement, article, notice or other communication published in any newsletter, magazine, or similar media or broadcast over television or radio; and

(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

There is no definition of "general solicitation" or "general advertising" in either the 1933 Act nor in Regulation D beyond that in Rule 502(c). Rather, the concept of what constitutes general solicitation and general advertising has evolved over the past 30 years through a series of "no-action" letters the SEC has issued or declined to issue, interpreting Regulation D or its predecessor, Rule 146. The SEC has noted that

[t]he analysis of facts under Rule 502(c) can be divided into two separate inquiries. First, is the communication in question a general solicitation or general advertisement? Second, if it is, is it being used by the issuer or by someone on the issuer's behalf to offer or sell the securities? If either question can be answered in the negative, then the issuer will not be in violation of Rule 502(c).65

In applying this two-part inquiry, the SEC noted that a determination as to whether there is general advertising for the sale of securities "requires an evaluation not only of the content of the specific advertisements but also of the actual use of each advertisement in relation to the offering of securities."66

The SEC has inferred actual use in relation to the offering of securities even where the issuer articulated an apparently legitimate business for the advertising that was unrelated to any offering of securities. For instance, the SEC declined to issue a no-action letter where the issuer was engaging in general advertising to sell its products at the same time as it was engaged in a private placement of securities, because the advertising could be deemed a part of its plan to offer and sell securities.67 The SEC also declined to issue a no-action letter where the issuer proposed to make a cold mass mailing of its private placement memorandum to at least 200 broker-dealers, investment advisers, accountants, and attorneys obtained from an organization's membership list.68 However, the SEC has issued no-action letters when communications, though public, were not deemed to have been made by or on behalf of an issuer. Specifically, the SEC has issued no-action letters when a person unaffiliated with any issuer desired to compile a guide that set forth public information about outstanding securities from selected issuers69 and also when non-profit entities proposed to create generally advertised matching services to match businesses needing capital with potential investors.70