On July 10, 2013, the Securities and Exchange Commission (“SEC”) adopted final rules eliminating a longstanding ban on the use of general solicitations and advertising in private offerings conducted under Rule 506 of Regulation D. Rule 506 is a widely-used safe harbor that allows issuers to offer securities to U.S. investors without registering those securities with the SEC. Under new Rule 506(c), issuers such as privately-held companies, hedge funds and private equity funds may advertise private offerings to the public through social media, television and other forms of mass communication. Issuers may alternatively rely on existing Rule 506(b) for private offerings, which will still prohibit general solicitations and advertisements. The final rules take effect in mid-September 2013 (i.e., 60 days after publication in the federal register).
In addition to adopting Rule 506(c), the SEC separately adopted final rules barring Rule 506 offerings that involve “bad actors” and proposed new rules that would heighten the compliance and disclosure requirements for Rule 506 offerings. This Client Advisory briefly summarizes the new and proposed changes to Rule 506. A more detailed analysis is available here.
REMOVAL OF THE BAN ON GENERAL SOLICITATIONS AND ADVERTISING. New Rule 506(c) permits issuers to advertise their private offerings to the general public and broadly solicit potential investors. In order to rely on Rule 506(c), however, issuers must:
- Sell their securities exclusively to accredited investors;1 and
- Take reasonable steps to verify each purchaser’s accredited investor status.
Unlike traditional Rule 506 offerings in which issuers customarily rely on an investor’s self-certification as an accredited investor, Rule 506(c) shifts the burden to issuers to make an independent, “reasonable” determination as to each purchaser’s accredited investor status. The SEC declined to adopt a list of specific verification methods it would consider “reasonable.” The SEC did, however, provide a non-exclusive list of measures that it would consider sufficient to verify a natural person’s accredited investor status, including:
- Reviewing copies of IRS forms that report income;
- Obtaining a certification of accredited investor status from an existing investor who participated in an issuer’s Rule 506 offering before the effective date of Rule 506(c); or
- Obtaining written confirmation from a broker, investment adviser, attorney or accountant that he or she has taken reasonable steps to verify a purchaser’s accredited investor status.
Issuers may also continue to rely on existing Rule 506(b). Rule 506(b) will still prohibit general solicitations and advertising, but it will not be subject to Rule 506(c)’s prohibition on sales to non-accredited investors or heightened accredited investor verification requirements.
SEC TO DISQUALIFY ALL RULE 506 OFFERINGS INVOLVING “BAD ACTORS.” The SEC separately adopted new Rule 506(d) of Regulation D, which disqualifies any offering made in reliance on either Rule 506(b) or 506(c) if the issuer or a covered person (e.g., officer, director, 20% shareholder or compensated solicitor) has had a “disqualifying event,” including:
- A criminal conviction in the past five years for securities-related violations;
- A suspension or expulsion from a self-regulatory organization; or
- Receipt of an SEC cease-and-desist or stop order issued within the past five years.
Rule 506(d) applies only to disqualifying events that occur after Rule 506(d) takes effect in mid-September 2013 (i.e., 60 days after publication in the federal register). Issuers relying on Rule 506(b) or Rule 506(c), however, will have to disclose to investors prior to a sale any matter that would have been a disqualifying event had Rule 506(d) been effective at the time.
SEC MAY SOON INCREASE RULE 506 DISCLOSURE AND COMPLIANCE OBLIGATIONS. On July 10, 2013, the SEC also issued proposed rules that, if adopted, would significantly impact how Rule 506(b) and Rule 506(c) offerings are conducted. If adopted, the proposed rules would:
- Require issuers to file a Form D at least 15 calendar days before a Rule 506(c) offering (Form D’s must currently be filed within 15 days of the first sale in a Rule 506 offering);
- Require issuers to file an amended Form D within 30 days of terminating a Rule 506 offering;
- Require issuers to include certain legends on general advertising materials; and
- Bar issuers from relying on Rule 506 for one year for late Form D filings.
Rule 506(c) should improve issuer capital raising efforts by increasing access to accredited investors through targeted social media campaigns, television ads and other advertising outlets. However, the SEC’s new rules will likely also increase issuers’ compliance costs, as issuers relying on Rule 506(c) will have to implement due diligence and recordkeeping procedures to verify each purchaser’s “accredited investor” status and that their principals and affiliates are not “bad actors.” We will continue to provide updates and analysis as changes to Rule 506 develop.