In April, the President signed into law the Jumpstart Our Business Startups Act (the "JOBS Act"). The JOBS Act is designed to enhance capital formation and improve access to capital markets. Accordingly, Title II of the JOBS Act requires the Securities and Exchange Commission (the "SEC") to relax prohibitions against general solicitation in certain private offerings. On August 29th, the SEC proposed rules to implement Title II.
Proposed Amendments to Rule 506 of Regulation D - Proposed Rule 506(c)
The JOBS Act directs the SEC to amend Rule 506 of Regulation D to provide that the prohibition against general solicitation contained in Rule 502(c) shall not apply to offers and sales of securities made pursuant to Rule 506, provided that purchasers of the securities are accredited investors. To implement the change, the SEC proposed new Rule 506(c), which permits the use of a general solicitation to offer and sell securities under Rule 506, provided that certain conditions are satisfied. These conditions are (1) the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors; (2) at the time of the sale of securities, all purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or because the issuer reasonably believes that they so qualify; and (3) all terms and conditions of Rule 501 (the definitions governing Regulation D), Rule 502(a) (covering integration) and Rule 502(d) (limitations on resale) are satisfied.
Under the proposed rules, whether an issuer has taken "reasonable steps to verify that the purchasers of the securities are accredited investors" will depend on the particular facts and circumstances of each transaction. This non-prescriptive approach reflects the marketplace reality that Rule 506 offerings vary from transaction to transaction and this approach is intended to provide flexibility to issuers in verifying an investor's status. The SEC will consider a number of interconnected factors when determining the reasonableness of the steps taken by an issuer to verify that a purchaser is an accredited investor. The SEC provided a non-exhaustive list of some of these factors, which include: the nature of the purchaser and the type of accredited investor that the purchaser claims to be; the amount and type of information that the issuer has about the purchaser; the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering; and the terms of the offering, such as minimum investment amount.
With respect to the nature of the purchaser, the SEC explains that as the definition of "accredited investor" in Rule 501(a) includes both natural persons and entities, the SEC expects the steps that would be reasonable for an issuer to take to verify whether a purchaser is an accredited investor would likely vary depending on the type of accredited investor that the purchaser claims to be. Regarding the amount and type of information that the issuer has about the purchaser, the more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it would have to take to reasonably determine accredited investor status, and vice versa. Finally, concerning the nature and terms of the offering, the SEC provides that an issuer who solicits new investors through a website accessible to the general public would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits investors from a database of pre-screened accredited investors maintained by a registered broker-dealer. The ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high that only accredited investors could reasonably be expected to meet it could also be considered a factor in verifying accredited investor status.
Although general solicitation and advertising will be permitted under new Rule 506(c), the SEC did preserve existing Rule 506(b) to allow issuers to conduct Rule 506 offerings without the use of general solicitation. Additionally, the SEC proposed a revision to Form D to add a separate filed or check box for issuers to indicate whether they are claiming an exemption under Rule 506(c).
Proposed Amendments to Rule 144A of the Securities Act of 1933
Section 201(a) of the JOBS Act also directs the SEC to revise Rule 144A of the Securities Act of 1933 to provide that securities sold pursuant to Rule 144A may be offered to persons other than Qualified Institutional Buyers ("QIB"), including by means of general solicitation, provided that securities are ultimately sold only to persons the seller, and any person acting on behalf of the seller, reasonably believes is a QIB. The SEC proposed amending the language of Rule 144A(d)(1) to remove references to "offer" and "offeree" which has the effect of allowing offers through general solicitation while requiring that the securities be sold only to a QIB or to a purchaser that the seller, and any person acting on behalf of the seller, reasonably believes is a QIB.
Private Funds May Rely on Proposed Rule 506(c) of Regulation D
Privately offered investment funds generally avoid the regulatory provisions of the Investment Company Act of 1940 (the "Investment Company Act") by relying on either Section 3(c)(1) (not more than 100 beneficial owners) or Section 3(c)(7) (all beneficial owners must be qualified purchasers), in order to be excluded from the definition of "investment company" under the Investment Company Act. One of the conditions to be met under both Sections 3(c)(1) and 3(c)(7) is that the investment fund is not making nor does it propose to make a "public offering" of its securities. The SEC has confirmed that private funds are permitted under the JOBS Act to make a general solicitation under proposed Rule 506(c) without losing the ability to rely on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act.