Group Investing Update
Changes to securities laws may change your business model.
other commercial real estate professionals are often involved with raising
money from groups of investors to purchase income-producing properties. Since
this activity generally means working under the federal securities laws, the
ability to advertise and solicit investors has historically been restricted.
However, the Jumpstart Our Business Startups Act, known as the Jobs Act, has
dramatically changed the way group investment money is going to be raised.
July 10, 2013, meeting, the Securities and Exchange Commission adopted the new
Regulation D, Rule 506(c) as authorized by the Jobs Act (Title II), which
became effective September 23, 2013. (See SEC Release No. 33-9415, Eliminating
the Prohibition Against General Solicitation and General Advertising in Rule
506 and Rule 144A Offerings.) Under the new
rule, persons such as issuers, sponsors, syndicators, or promoters selling
“securities” to private investors to fund their companies or real estate
transactions will be able to advertise their private-investment opportunities
under certain conditions.
who is raising money from multiple investors is probably selling securities.
Securities include promissory notes or investment contracts between a manager
and passive investors. Under the Securities Act of 1933, sales of securities
must be registered with the SEC unless exempt.
far the most common exemption has been the Rule 506 private offering exemption.
As much as $898 billion may have been raised in Rule 506 offerings in 2012,
according to the SEC. From 2009 to 2012, the average offering size was $30
million and the median offering size was $1.5 million.
The Old Rule 506
original Rule 506, which will now be known as Rule 506(b) and is still in
effect, issuers of securities are exempt from SEC registration as long as they
follow the rules for the exemption. Rule 506(b) allows issuers to raise an
unlimited amount of money from an unlimited number of accredited investors and
up to 35 “sophisticated” investors, but issuers cannot make any offers or sales
of the securities by any means of general advertising or solicitation. To prove
they didn’t solicit investors, issuers must be able to demonstrate a
pre-existing relationship with an investor that predates any current or
contemplated offer to sell securities. For issuers relying on Rule 506(b),
investors may self-certify that they are accredited or sophisticated by
checking a box on a prequalification form the issuer provides.
real estate syndicators who want to issue their own securities, the
pre-existing relationship and nonsolicitation provisions of Rule 506(b) have
been a source of great confusion, misinterpretation, and a significant
impediment to funding their real estate transactions. The new Rule 506(c), which
allows syndicators to advertise their real estate offerings, eliminates that
obstacle and provides new opportunity for CCIMs and other commercial real
The New Rule 506(c) Solution
Rule 506(c), real estate syndicators can advertise to anyone as long as they
only accept accredited investors in their offerings and comply with the rest of
the Rule 506(c) provisions.
there are strings attached. Issuers of Rule 506(c) offerings must demonstrate
that they are “reasonably assured” that all investors are accredited. The SEC
has offered some nonexclusive methods to verify an investor’s accredited
status, which include:
filed tax forms for the past two years and written assertions from the
investor(s) that the income is expected to continue;
brokerage house or bank statement balances or tax assessments and third-party
appraisals of real estate holdings and liabilities through an investor’s credit
a written confirmation from a securities broker-dealer, registered investment
adviser, licensed attorney, or certified public accountant, who asserts having
taken reasonable steps to verify an investor’s accredited status within the
past three months; and
repeat investors: there is an exemption for investors who have previously
invested with an issuer as an accredited investor.
“Bad Boy” Prohibitions
also adopted amendments to existing rules 501 and 506 to implement Section 926
of the Dodd-Frank Act, also effective September 23, 2013, to be known as Rule
506(d). These amendments disqualify certain convicted felons and other “bad
actors” from claiming a Rule 506 exemption. Bad actors are defined as persons
who have been convicted of, or are subject to, a cease-and-desist order,
injunction, or disciplinary order issued by certain federal financial
regulatory agencies or the Postal Service. If these events occurred before the
effective date of September 23, 2013, these individuals may still operate under
Rule 506, but mandatory disclosure of such disqualifying events is
SEC has proposed other amendments to Rule 506(c) offerings, including requiring
additional Form D filings for presale, first sale, and closing notices of
securities; filing of additional information about the issuer, marketing
methods to be used, additional legends, and disclosures; and temporarily
submitting written ads to the SEC prior to use. The SEC is taking public
comment on these amendments and the final rule could be issued by
Clarifying Crowd Funding
none of these rulings should be confused with crowd funding, which is
completely unrelated to Rule 506. Crowd funding is a different funding scenario
authorized in a separate part of the Jobs Act (Title III). The premise is that
investors will be able to invest as little as $1,000 for offerings advertised
through SEC-authorized funding portals. To further confuse matters, the media
and certain promoters have hijacked the term crowd funding
to describe Rule 506(c) offerings conducted on the Internet.
Internet and news reports to the contrary, the SEC has not approved crowd
funding. On October 23, 2013, the SEC met and the commissioners voted to submit
for public comment the proposed rule that will authorize crowd funding. The
public comment period is 90 days. After that, the SEC will determine if
revisions to the proposed rule are required and vote on a final rule. The rule
becomes effective 60 days after it is published in the Federal Register. Crowd funding will probably become a reality
during first quarter 2014. However, according to the SEC’s own website, until
the final rules are effective, all crowd funding offerings are unlawful.
the changes authorized in the Jobs Act are exciting, many have yet to be
implemented. Commercial real estate professionals involved with group investing
should proceed with caution and verify information heard in the media and on
the Internet through the most reliable source: www.sec.gov.
Lisa Taylor, Esq., is a California and Florida
licensedattorney with practice areas in real estate investment and
securities law. Contact her at firstname.lastname@example.org. Gene
Trowbridge, Esq., CCIM, is a California licensed
attorney, senior CCIM instructor, and author of “It’s a Whole New Business,” on real estate syndication. Contact him at
email@example.com. A version of this article previously appeared in Personal Real Estate Investor.