As a follow up to my previous blog post where I discussed the new CDIs relating to the definition of "general solicitation" in private offerings conducted under Rule 506(b), I decided to discuss the recently issued SEC no-action letter to Citizen VC. This no-action letter is all about the application of the new SEC guidance regarding general solicitation in practice. This can serve as a useful tool for conducting private placements over the Internet.
The main question was the establishment of a "substantive pre-existing relationship" between CitizenVC and prospective investors that would allow the issuer to conduct Rule 506(b) private placements without engaging in general solicitation. The definitions of "substantive" and "pre-existing" were recently clarified by the SEC (CDI Questions 256.26-31). According to the SEC (CDI Questions 256.29 and 30), a "pre-existing" relationship is one that is established prior to the commencement of the offering. There is no minimum waiting period so long as the relationship was established before the offering started. According to the SEC (CDI Question 31), 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."
Now, let's take a look at the facts described in the CitizenVC request for the no-action letter.
CitizenVC is an online venture capital firm that offers LLC membership interests in SPVs formed for the purpose of investing into emerging growth companies. The offering is done through their website. CitizenVC intends to conduct the private placements under Rule 506(b) that does not allow the use of general solicitation. To avoid general solicitation, CitizenVC first seeks to establish substantive relationships with its prospective investors.
First, the CitizenVC website that is viewable by the general public does not contain any information that could be viewed as an "offer". There is no information about the current SPVs, portfolio companies, investment opportunities or offering materials. This is consistent with the SEC guidance (CDI Questions 256.23-25) that states that the use of a publicly available website that contains an offer of securities constitutes a general solicitation. To avoid this, the issuer should only disclose "factual business information that does not condition the public mind or arouse public interest in a securities offering" by that issuer.
Second, all visitors to the site that are interested in becoming a member of an SPV must complete an online accredited investor questionnaire. Only those members who self-certify themselves as "accredited" will eventually receive a password that will allow them to access restricted portions of the site.
Third, CitizenVC implements its pre-set procedures (that contain six separate steps) to establish a substantive relationship with the prospective investor, including (1) contacting the prospective investor offline to discuss their experience and sophistication and to answer questions; (2) sending an introductory email; and (3) using third party credit reporting services to confirm identity and gather additional financial information and credit history information. Once CitizenVC is satisfied that the prospective investor has sufficient knowledge and experience in financial and business matters and that a substantive relationship has been created, it will admit him or her as a member of the website and send a password to the "member only" areas of the website that contain investment opportunities.
Once enough members indicate interest in an opportunity, CitizenVC will create an SPV to aggregate such members' investments. Members will be given subscription materials that will contain additional risk disclosures and detailed accredited investor certifications and representations.
The most important aspect of this no-action letter is that the issuer has no minimum waiting period to establish a substantive relationship with a prospective investor. For CitizenVC, it is the question of quality of such a relationship rather than its duration. Completion of a "check the box" accredited investor questionnaire alone does not establish such a relationship. On the other hand, a 30-day waiting period is also not necessary (See Lamp Technologies No-Action Letter). As the SEC confirmed in its response to CDI Question 256.31, a "substantive" relationship is established when the issuer "has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree's financial circumstances and sophistication." That may take a week or a month, depending on the circumstances.
In conclusion, the CitizenVC no-action letter offers an excellent step-by-step guide on how to conduct online private placements in compliance with the requirements of Rule 506(b). All issuers currently structuring their investment platforms should closely study and analyze this example.
This article is not a legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.