December 14, 2021

Specific Questions and Answers Regarding Reg D, Rule 506 B

Is it possible to create a Facebook group on real estate investing and then proceed to execute an email or messaging blast about our fund? How long does a group need to be established before being considered a legitimate pre-existing relationship?

This is a very important question. While you might think that establishing a Facebook group can be constituted as a pre-existing relationship and is therefore exempt from the general solicitation rules, this is not true.

When it comes to Facebook groups, it isn’t wise to directly solicit your offering on that group because there is no way of determining the seriousness of the relationship between you and your Facebook group members. Just because someone has clicked on the join button doesn’t mean that you have established a legitimate relationship.

Facebook groups are great in that they can open the door to a future relationship. However, just because you have members that have joined the group doesn’t give you the right to solicit your investment to them through a marketing blast.

With this in mind, it is important to know that not everyone in your group might be who they claim they are. Specifically, with real estate investing groups, it has been shown that many regulators have started to join these kinds of groups. This could prove to be detrimental to your securities offering if they find you non-compliant with the regulations outlined in Regulation D Rule 506 B.

With this in mind, it is wise to stay away from doing any kind of marketing blast to Facebook group members. Many people have had problems in the past when using Facebook to get new investors. In many cases, using Facebook in this manner can result in a deposition where the prosecutor will be able to reference all Facebook postings. Therefore, when offering a 506 B opportunity, you should stay away from Facebook group marketing blasts.

Does the same apply to Section 506 C offerings?

Generally, the rules for a 506 offering are going to be different from a 506 B. Technically, general solicitation is allowed through a 506 C. However, there are still regulations that you should be aware of. Many of these Facebook groups are private and will have specific forms that need to be filled out to be eligible to join. However, even with that, it can still be difficult to prove that you’ve established a substantive pre-existing relationship with those investors. The idea that you would know any particular investor well enough through Facebook to determine that a particular investment is right for them will be difficult to prove in court for a 506 B offering. With this in mind, it is usually prudent to have another mechanism in place to establish a pre-existing relationship that isn’t on Facebook.

Let’s say I take a potential investor out for a meeting without explicitly discussing my offering. Instead, we talked about sports and the weather. Then I decide to schedule another meeting with them. Would I be able to pitch my investment the following week during another meeting?

This is another excellent question. What it will come down to is whether or not you’ve established a substantive relationship in that first meeting. An attorney representing you will argue yes. A regulator, on the other hand, might argue not. With the power that regulatory bodies have, you might be required to return any money given out if it was obtained in this way.

At the end of the day, it might be wise to establish more than one meeting before pitching and selling an investment offering. While you might be able to get away with it, the risk might not be worth the reward. Generally speaking, the longer you’ve known a potential investor, and the more interaction you’ve had with them, the better.

If you had a coffee with someone where you just have a surface-level introductory meeting, it’s kind of hard to classify that as a substantive relationship. You can’t be going out for coffee one day and jump to pitching a securities investment in the next.

Creating a substantive relationship will ultimately entail more than just talking about baseball and the weather. You will need to gauge your potential investor’s level of sophistication and their general finances. You don’t need to be invasive, but it’s good to have an idea of their level of investment experience. This can include what kind of investments they’re currently making or investments they’ve made in the past. Knowing if they have sufficient funds to invest in a way that won’t lead them to financial ruin if it doesn’t work out is important.

Knowing this information is essential if you’re trying to legitimately pitch an investment deal to someone. Not knowing the answers to some of these questions only serves to prove that you shouldn’t have been marketing your investment to them in the first place. Getting funds from people with who you haven’t established a relationship with and haven’t vetted thoroughly can lead to SEC scrutiny if they find out you’re soliciting unsophisticated investors.

Another thing to keep in mind in this scenario is that it is extremely difficult to document these types of meetings. Realistically, if an investor complains to a regulator, they will most likely say something like, “We just went out for coffee, and I barely knew the person. Before you know it, he pitched me a deal that put my life’s savings at risk.”

Regulators hearing something like this will ultimately side with the unqualified investor, which could leave you with having to pay back their investment. With that in mind, it can be emphasized enough how important it is to have developed a substantiated relationship. The last thing you want is a regulator knocking on your door asking you how you met the investor. If you respond with, we met for coffee and talked about sports, that could raise some major red flags and show the regulator that there was no real substantive relationship there when the investment was pitched.

How do I determine if the investor I’m dealing with is sophisticated, and how many unaccredited investors can I have invested in my offering?

According to Regulation D Rule 506 B, investors do not need to be considered sophisticated to invest in your securities offering. However, the investment must be deemed as a suitable one for them. But what does suitable mean? Suitable simply refers to the fact the investor has a solid understanding of what they’re investing in. It also requires that their investment isn’t a significant percentage of their net worth. These are the main issues discussed when it comes to the suitability of the investment.

As far as how many investors you’re allowed to bring on, this is typically limited to 35 investors. Interestingly enough, accredited investors are not considered investors under 506 B. With that said, any accredited investor will not count toward your 35-investor limit. This is an important distinction to make to fully understand who’s allowed to invest and how many investors are allowed to participate. Generally, as long as your investors are sophisticated and understand the risks involved in their investment, they will be counted toward the 35-investor limit. Accredited investors, on the other hand, are not included in this investor limit.

Can you present investment information to someone who specifically asks about your securities offering?

This can be seen as different from directly soliciting your investment. However, in the eyes of regulators, it doesn’t make a difference. In fact, there have been many instances where regulators have actually called companies who are actively selling investment offerings, saying that they would like information and that they’re accredited investors, so you don’t need to worry.

In this case, they’re trying to test you to see if you will move forward in providing them the information they requested. By cooperating with this request, you could quickly find yourself in legal trouble seeing as you’re providing investment information to someone you haven’t established a serious pre-existing relationship with.

To avoid this scenario, you should only deal with people you know, trust, and have done business with in the past. If someone calls you out of the blue asking for your deal, their request should be met with skepticism. Your first question should be, why are they asking me this? Then you might ask, where are they calling from? What three-letter agency do they belong to? Having this knowledge when receiving these types of calls can save you from making a huge mistake of dealing with someone you don’t have a sufficient prior relationship with.

If they aren’t working with a regulatory agency, it would be best to just take down their information and stay in touch with them. You could pitch your next deal with them down the road. However, you shouldn’t directly offer an investment to someone you just met.

How does the 35 unaccredited investor limit rule work? Is it 35 per year? How can this rule be defined?

The recent change to this rule happened in March, making it a relatively new regulation. However, it states that you can sign on 35 new unaccredited investors every 90 days. But what do 90 days mean? This is many times subject to interpretation. Because of how new this rule is, it has not been made entirely clear. However, most legal experts interpret it as any 90 day period throughout the year. As long as there are less than 35 unaccredited investors or less, you shouldn’t run into any issues.

With that said, it is difficult to interpret the new rule as being limited to only 35 per year. It seems to say that you can specifically include 35 new investors every 90 days.

Can I pitch my investment with a series 22 license? Or do I need to be represented by a broker-dealer? Does having a series 22 allow me to legally pitch private real estate deals?

This is another great question. It is important to know that you can’t get your series 22 unless you’re sponsored by a broker-dealer who would like to work with you. With that in mind, having a series 22 doesn’t matter. When selling investments, you’re licensed, or you’re exempt from licensing broker-dealers. Having a series 22 license gives you the ability to sell private deals. However, those who aren’t licensed will rely on the issuer exemption.

The issuer exemption gives you substantial duties and obligations that extend beyond just raising capital. At the end of the day, you’re not getting paid for raising capital. You’re only doing work with an issuer once per year. If you haven’t been working with another broker-dealer over the last year, it is suggested to leave that broker-dealer and do deals on your own. This can prevent you from having to wait 12 months before you can rely on an issuer exemption.

Final Thoughts

Having gone over some important questions regarding the solicitation and marketing of your securities offering, we hope that you can take the insights provided in these answers and go on to offer your investment in a way that is compliant with the regulatory agencies. While there are many limitations on the ways, you can market your investment offerings, knowing the importance of having established investor relationships can go a long way in keeping you safe from regulatory scrutiny. Overall, it is essential to have a substantive pre-existing relationship before taking any investment money from an individual. The new rule allows up to 35 unaccredited investors to sign on every 90 days. However, these investors need to have a good idea of what they’re getting into. Providing potential investors with the necessary information they need to make an informed decision is paramount. Additionally, it is important to know your investor’s financial situation and make sure that they aren’t investing a significant portion of their net worth. By knowing all of these details, you can rest assured that you’re conducting your investment offering in a compliant manner.

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