Substantive Pre-Existing Relationships Possible in On-Line Private Placements

On August 6, 2015, the Securities and Exchange Commission (SEC) issued a No Action Letter to Citizen VC, Inc. (CVC) that appears to have further loosened the prior No Action Letter guidance provided by the SEC related to the ban on general solicitation and the creation of substantive pre-existing relationships in private placements.

Counsel for CVC noted in its initial Incoming Letter that they believed the quality of the relationship between an issuer and an investor is the most important factor to be considered in determining whether a pre-existing, substantive relationship has been established for purposes of offerings made in private placements pursuant to Rule 506(b) of Regulation D.  Additionally, the historical No Action Letter guidance of the SEC points to establishing a process for issuers to develop substantive relationships with previously unknown investors, and that this process can be undertaken in a manner that will not contravene the prohibition of general solicitation and general advertising under Rule 502(c).  Thus, the relationship between issuer and investor is not built through a specific duration of time or a short form accreditation questionnaire , but rather, it can be established by adhering to specific policies and procedures both online and offline(where appropriate), which enable the issuer to evaluate the prospective investor’s financial sophistication, circumstances, suitability, and his or her ability to understand the nature and risks of the Interests to be offered.

The SEC agreed with the analysis of CVC, and stated in No Action Letter that “We agree that the quality of the relationship between an issuer (or its agent) and an investor is the most important factor in determining whether a “substantive” relationship exists. As the Division has stated before, a “substantive” relationship is one in which the issuer (or a person acting on its behalf) 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 … We note your representation that CVC’s policies and procedures are designed to evaluate the prospective investor’s sophistication, financial circumstances and ability to understand the nature and risks of the securities to be offered. We also agree that there is no specific duration of time or particular short form accreditation questionnaire that can be relied upon solely to create such a relationship.”

The SEC’s position provides further clarification on what is necessary to create a pre-existing relationship, along with  how much time is necessary to build the relationship.  It is clear that this No Action Letter, when read in conjunction with the more recent No Action Letters issued by the SEC on this issue, will provide a road map for issuers that want to utilize on-line platforms to offer private placements, without violating the ban on general solicitations in private placements.