Avoiding General Solicitation: Strategies for SEC Compliance

With the U.S. Securities and Exchange Commission’s (SEC) rules prohibiting general solicitation, investors and organizations must be strategic when raising capital to avoid penalties. Understanding what constitutes general solicitation, the SEC’s regulations, and strategies to comply are critical for entrepreneurs, investors, and investment managers. With thoughtful preparation, companies can successfully fundraise while steering clear of prohibited activities.

What Is General Solicitation?

Definition

General solicitation refers to advertising or marketing activities aimed at a broad, public audience to recruit investors for a private offering. This includes public communications like online ads, social media posts, mass emails, or public events. The SEC prohibits general solicitation under Regulation D for private securities offerings to reduce fraud risk and prevent sales to unaccredited investors. These laws protect investors and promote fair markets by limiting exposure to unsuitable investments and maintaining market integrity.

General Solicitation and the SEC

SEC Rules on General Solicitation

The SEC has established several rules to restrict general solicitation and private securities offerings. The main rules include:

Regulation D: Regulation D provides exemptions from registration requirements for private offerings. Rule 506(c) allows general solicitation for accredited investors under certain conditions.

Rule 506(c): This rule allows general solicitation if the company only sells securities to accredited investors and takes reasonable steps to verify their status. Companies must file a Form D with the SEC within 15 days of the first sale.

Strategies and best practices to avoid general solicitation

Recommendations to follow

Limit communications

Limit communications to individuals with whom the company already has an established relationship. Only communicate with current customers, vendors, employees and other pre-existing contacts.

Vet potential investors

Vet potential investors to confirm accredited status before sharing deal details. This includes reviewing documents like tax returns, bank statements, credit reports and account statements to verify that the investor meets the SEC’s income or net worth thresholds. Target limited partners who are wealthy enough to withstand potential loss of the investment.

Establish substantive relationships

Build substantive relationships with potential investors before sharing fund materials. Understand their investment background and experience. Personalize outreach rather than sending generic emails, tailor the pitch to match investors’ specific needs and interests.

Use secured platforms

Use password-protected online platforms for communications and information sharing. Restrict access to any portals, data rooms or websites used for deal materials through access control lists and passwords.

Ensure compliance in marketing materials

Review all marketing materials for compliance. Have legal counsel review all advertisements, social media posts, presentations and other materials to ensure they do not constitute improper solicitation

Avoid

• Refrain from making public statements to the general public, sharing fund information on social media platforms or issuing press releases while fundraising.
• Do not operate a publicly accessible fund website containing your investment thesis or contact information for the purpose of fundraising.
• Avoid speaking at events, seminars, webinars or meetings where strangers are invited and where you would discuss the fund thesis or investments while fundraising.

Consequences of Violating General Solicitation Rules

Legal and Regulatory Penalties

Failing to comply with general solicitation regulations can have severe legal and financial consequences. Companies found in violation risk losing their securities offering exemptions, which could lead to costly administrative actions or civil lawsuits from the SEC and other regulators. Potential penalties include stiff fines up to $73,000 or orders to unwind investments, making it challenging for violators to raise capital legally in the future.

Investor Backlash and Reputational Damage

Even if regulatory penalties are avoided, violations can still invite legal action from disgruntled investors seeking remedies like rescission of their investments. Publicized violations also risk severe reputational damage that could scare off future investors and partners. In extreme cases, authorities may bar violators from fundraising activities for 5-10 years, crippling a company’s ability to secure growth capital.

Ongoing Scrutiny and Investigations

General solicitation violations often trigger investigations that can linger for months or years. Anyone can report suspected violations to regulators, leading to protracted legal battles and reputational harm even if no wrongdoing is ultimately proven. The associated legal costs, management distractions, and operational disruptions can prove devastating for cash-strapped startups and small businesses.

With substantial financial, legal, and reputational risks at stake, adhering diligently to general solicitation regulations is critical. Consult qualified legal counsel to ensure full compliance and avoid potentially existential consequences.

Conclusion

General solicitation laws present complex compliance challenges for companies seeking capital, but with careful planning and execution, issuers can avoid pitfalls. Following best practices around marketing, communications, and documentation provides a framework to access capital while steering clear of onerous legal risks. Though regulations continue to evolve, the principles of prudent advance preparation, close attention to SEC guidelines, and common sense judgment remain key to successful capital raising campaigns in full compliance with prohibitions on general solicitation.