"General Solicitation" under Federal Securities Laws
By John Jacob Tollefsen
[written before Reg D 506(c) adopted]
The small business raises all the capital it
can from friends, relatives, and everyone it knows who has money. In
order to expand its fundraising to new potential investors, it hires
a securities lawyer. Then the small business learns the bad news: It
cannot raise money from anyone with whom it does not have a
substantial pre-existing relationship. Otherwise it will violate the
prohibition against general solicitation.
History of the Rule
Section 4(2) of the Securities Act of 1933, as
amended (“1933 Act”) exempts from registration transactions by an
issuer not involving a “public offering.” In 1935, (Securities Act
Release No. 33-285), the SEC defined no public offerings in terms of
an offering to a defined group of offerees. The number of the
offerees and their relationship to each other and the issuer. It
held “an offering to a given number of persons chosen from the
general public on the ground that they are possible purchasers may
be a public offering even though an offering to a larger number of
persons who are all members of a particular class, membership in
which may be determined by the application of some preexisting
standard, would be a non-public offering.” Several courts adopted
the language of this Release to define the Section 4(2) exemption.
In Securities and Exchange Commission v.
Sunbeam Gold Mines Co., 95 F.2d 699, 701 (9th Cir. 1938), the court
[A]n offering of securities to all residents of
Chicago or San Francisco, to all existing stockholders of the
General Motors Corporation or the American Telephone & Telegraph
Company, is no less “public,” in every realistic sense of the word,
than an unrestricted offering to the world at large. Such an
offering, though not open to everyone who may choose to apply, is
nonetheless ‘public’ in character, for the means used to select the
particular individuals to whom the offering is to be made bear no
sensible relation to the purposes for which the selection is made.
As a result of this thinking, the SEC
emphasized the number of offerees setting the arbitrary figure of 25
as a test of whether an offer was public. This numerical limit
prevented general solicitation. In Securities and Exchange
Commission v. Ralston, Purina Co., 346 U.S. 119 (1953), the Supreme
Court explicitly rejected the SEC’s claim that a numerical test of
25 offerees should govern and rejected the SEC’s contention that the
number of offerees was the critical factor. The Court held:
We are advised that “whatever the special
circumstances, the Commission has consistently interpreted the
exemption as being inapplicable when a large number of offerees is
involved.” But the statute would seem to apply to a “public
offering,” whether to few or many. It may well be that offerings to
a substantial number of persons would rarely be exempt. Indeed,
nothing prevents the Commission, in enforcing the statute, from
using some kind of numerical test in deciding when to investigate
particular exemption claims. But there is no warrant for
superimposing a quantity limit on private offerings as a matter of
statutory interpretation . . . .
“No particular numbers are prescribed.
Anything from two to infinity may serve: perhaps even one . . . .”
Id. at 125 and n.11.
Instead of relying on the number of individuals
involved, the Court stated that application of the exemption “should
turn on whether the particular class of persons affected needs the
protection of the Act” or whether such persons are able “to fend for
themselves.” Id. at 124-25. The chief problem with general
solicitation is that it may in fact reach some persons who do need
the protection of the 1933 Act because they lack access to the kind
of information registration ordinarily provides.
In 1974, the SEC adopted Rule 146 as a
nonexclusive means of establishing compliance with Section 4(2). The
rule limited offerees to 35. General solicitation and general
advertising were prohibited and issuers were required to pre-screen
offerees and evaluate their financial condition and
In 1980, the ground work for Regulation D was
raised by the Small Business Development Act which authorized the
SEC to exempt from registration offerings up to $5 million. In 1982,
Rule 146 was superseded by Regulation D. “General solicitation” and
“general advertising” continued to be bared without a least an
underlying state registration.
Defining General Solicitation
“General solicitation" or "general advertising"
are undefined in the statutes or rules. Instead, the Securities and
Exchange Commission (SEC) takes a case by case approach. Rule 502(c)
any advertisement, article, notice or other
communication published in any newspaper, magazine, or similar media
or broadcast over television and radio; and
any seminar or meeting whose attendees have
been invited by any general solicitation or general advertising."
In no action letters, the SEC has stressed the
importance of the existence and substance of a "pre-existing
relationship" with potential investors as a key indicator of
determining if a communication is a "general solicitation" or
constitutes "general advertising.” According to the SEC, the
presence of a pre-existing relationship between an issuer and a
potential investor is strong evidence that general solicitation or
general advertisement has not occurred. The SEC declined to take
enforcement action against issuers for any of the following actions:
Submitting a generic questionnaire to investors
during the fundraising period, provided that the questionnaire did
not specify or promote a particular investment, but simply
questioned the suitability of potential investors. These investors
cannot participate in any pending offering.
Providing password protected information on the
Internet to potential investors who had already been determined by
the issuer to qualify as accredited or sophisticated investors.
Speaking (including an interview to the media
about a company so long as the discussion is generic in nature and
does not reference any investment currently offered or contemplated.
Discussing a company or new product as long as
no current funding initiatives or historical investment results are
On the other hand, the SEC has indicated that
it believes that the following actions violate Rule 502(c):
Speaking to the media about a solicitation when
funding or investment matters are discussed, whether such speech is
directed at current fundraising efforts or deemed to be an attempt
to "condition the market" by making reference to the success or
attractive return of previous investments.
Print, radio and television advertisements or
solicitations regarding funding or investment matters
Tombstone advertising (an ad which does no more
than give the barest of information) is held by SEC staff to
"condition the market" for the securities and therefore constituted
an offer even though the tombstone did not specifically mention the
transaction in question.
Is a mass mailing to venture capitalists
general advertising or solicitation? The SEC has not ruled.
So what is general solicitation and general
advertising? Taken together, the no-action letters indicate a staff
view that general solicitation does not occur when the solicitor and
his targets have a nexus: as the SEC puts it, a "substantial
preexisting" relationship. It is assumed by many that vicarious
relationships qualify. Presumably, your lawyer, accountant, banker,
as well as officers, directors, and management level employees can
make the material available to potential purchasers with whom they
are acquainted. There is so much uncertainty that no one can say for
certain if the offering has qualified for an exemption.
Keep careful records. The issuer has the burden
of proving compliance with the exemption.
Proposals for Reform
Since the mid-1980s, there have been several
solutions proposed including a finder broker-dealer, licensing
investors, and permitting general solicitation of accredited
investors. All have been rejected as a result of a deep-seated bias
against any softening of the line between public and private
offerings. The SEC staff has been generally unsympathetic to the
proposals. Most are young inexperienced lawyers and accountants or
Several proposals are under consideration each
year. Hope springs eternal.
Many entrepreneurs violate the prohibition
against general solicitation (at least technically) because they do
not have a substantial pre-existing relationship will all the
investors in the venture. Often federal rules against commissions
and finders’ fees are violated. Typically the SEC takes no
The primary risk is not SEC enforcement, but
loss of the private placement exemption through less than strict
compliance with the rules of the exemption. General Solicitation is
not protected by the substantial compliance safe harbor of
Without an exemption, the issuer, salespeople,
officers, directors, and agents may be personally liable to the
investor. The investor can recover the principal, interest, and