In mid-2015, Citizen VC, Inc. (“Citizen VC”), an online venture capital firm offering securities, requested no-action relief from the U.S. Securities and Exchange Commission (the “SEC”). In granting the no-action request, the SEC clarified procedures that can be used to establish a preexisting, substantive relationship with investors so as to avoid "general solicitation and general advertising". The letter is instructive to anyone looking to structure an online private placement in reliance on Rule 506(b) under Regulation D (“Regulation D”) under the U.S. Securities Act of 1933, as amended (the “Securities Act”).
C&DIs – Clarification of “Pre-Existing” and “Substantive”
In their request for no-action relief, Citizen VC outlined their procedures for ensuring that all purchasers of their securities had a pre-existing, substantive relationship with them prior to making any investment. Establishing this relationship was essential as Citizen VC wished to rely on Rule 506(b) of Regulation D (“Rule 506(b)”) and therefore needed to avoid conducting general solicitation and general advertising so as to avoid falling under Rule 506(c) of Regulation D (“Rule 506(c)”) with its more onerous “Accredited Investor” (as defined in Regulation D) verification requirements.
“Pre-existing” and “substantive” were recently clarified by the SEC in its Compliance and Disclosure Interpretations (“C&DIs”) 256.26-31. According to the SEC, a “pre-existing” relationship is one that is established prior to the commencement of the offering and a “substantive” relationship is one where the issuer “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.” In C&DI 256.30, the SEC made clear that there is no minimum waiting period required for an issuer to establish a pre-existing, substantive relationship with a prospective investor.
Citizen VC No-Action Request
Citizen VC is an online venture capital firm that offers limited liability company interests in special purpose vehicles (“SPVs”) for the purpose of investing in seed, early-stage, emerging growth and late-stage private companies. To avoid general solicitation and general advertising, Citizen VC sought to establish a substantive relationship with its prospective investors through the following means:
- the website viewable by the general public did not contain an “offer” but instead only contained factual business information;
- all prospective investors had to complete an online Accredited Investor questionnaire where they had to self-certify their Accredited Investor status to eventually be issued a password to access restricted portions of the website including information regarding the current SPVs, portfolio companies, investment opportunities and offering materials;
- Citizen VC implemented six separate procedures, including:
- contacting the prospective investor by telephone to discuss their sophistication and answer questions;
- sending an introductory email to the prospective investor;
- contacting the prospective investor online to answer questions that they may have about Citizen VC and its related investments;
- using third party credit reporting services to confirm the identity and further assess the prospective investor’s suitability;
- encouraging the prospective investor to explore the website and ask questions; and
- generally fostering interactions both online and offline.
The waiting period was not subject to a set limit of days; the company would move forward with issuing the password if they had taken all the steps in assessing the prospective investor’s suitability.
Citizen VC No-Action Relief
Based on the representations and facts, the SEC issued no-action relief to Citizen VC. This approach by the SEC emphasises that the analysis of investor sophistication depends on facts and circumstances and is not dependent on a specific duration of time (i.e., 30 days or otherwise) to create a substantive relationship. The Citizen VC No-Action Letter offers an important and timely guide on how to conduct online private placements in reliance on Rule 506(b).
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