The Jumpstart Our Business Startups Act (JOBS Act) required the Securities and Exchange Commission (SEC) to revise its current rules to allow companies issuing securities in a private offering pursuant to Rule 506 of Regulation D of the Securities Act of 1933 (Securities Act) and Rule 144A of the Securities Act to use general solicitation and general advertising—such as newspaper advertisements, communications over television or radio, public websites or seminars in which attendees are invited through a general advertisement—in their offering efforts, as long as the actual purchasers of the securities are accredited investors1 or reasonably believed to be qualified institutional buyers (QIBs).2 On August 29, 2012, the SEC proposed the following rules to implement this directive.
The SEC has proposed a new Rule 506(c), which would permit the use of general solicitation and general advertising to offer and sell securities, provided that:
- all purchasers of securities are accredited investors; and
- the issuer takes reasonable steps to verify that purchasers of the securities are accredited investors. [Italics added.]
The key concept of “reasonable steps to verify” comes straight from the JOBS Act. Under existing Rule 501(a) (which the SEC does not propose to amend), an accredited investor is defined as a person or entity who meets, or the issuer reasonably believes meets, certain criteria. Although the SEC stated that it anticipated that many practices currently used by issuers in connection with existing Rule 506 offerings to substantiate their “reasonable belief” as to investor status would satisfy the verification requirement proposed for offerings pursuant to Rule 506(c), the “reasonable steps to verify” standard is intended to have a meaning separate from the Rule 501(a) “reasonably believes” requirement.
In determining the reasonableness of the steps that an issuer has taken to verify that a purchaser is an accredited investor, the SEC’s proposing release explains that issuers are to consider the facts and circumstances of the transaction. This includes, among other things, the following factors:
- the type of 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; and
the nature of the offering, meaning:
- the manner in which the purchaser was solicited to participate in the offering; and
- the terms of the offering, such as a minimum investment amount.
The proposing release notes that proposing specific verification methods that an issuer must use “would be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor,” and could also force issuers to follow steps that were perhaps not appropriate in a certain instance. The SEC gave the example of an issuer that solicits new investors through a widely disseminated social media advertisement, as opposed to an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a registered broker-dealer. In the first case, “reasonable steps” would require something more than presenting a box on a questionnaire, whereas in the latter case, it would be reasonable for the issuer to rely on the broker-dealer to have verified an investor’s status as an accredited investor.
The proposed rules would preserve the existing portions of Rule 506 as a separate exemption under Rule 506(b), so that companies conducting offerings pursuant to Rule 506—but without the use of general solicitation and general advertising— would not be subject to the new verification rule or the requirement to sell only to accredited investors. (The existing Rule 506 allows for securities to be sold to up to 35 non-accredited investors who meet certain sophistication requirements.)
Under the proposed rules, securities resold pursuant to Rule 144A could be offered to persons other than QIBs, including by means of general solicitation or general advertising, provided that the securities are sold only to QIBs or persons whom the seller and any person acting on behalf of the seller reasonably believe is a QIB.
The proposed rules would amend Form D, which issuers must file with the SEC when they sell securities under Regulation D, to add a separate box for issuers to check if they are claiming the new Rule 506(c) exemption. The current Rule 506 box will be relabeled as Rule 506(b).
Integration with Offshore Offerings
The SEC noted that many commentators wanted clarity as to how any amendments to Rule 506 and Rule 144A would affect the Regulation S safe harbor. Currently, Regulation S provides a safe harbor for offers and sales of securities outside the United States, as long as (i) the securities are sold in an offshore transaction and (ii) there are no directed selling efforts in the United States. A general solicitation such as placing an advertisement in a publication with a United States circulation is regarded as a “directed selling effort.” The SEC stated that under the proposed rules, concurrent offshore offerings that are conducted in compliance with Regulation S would not be integrated with domestic unregistered offerings that are conducted in compliance with Rule 506 or Rule 144A, as proposed to be amended.
Expedited Rulemaking Process Urged
The JOBS Act required the SEC to implement the changes to Rule 506 and Rule 144A within 90 days from the date of its enactment, which was April 5, 2012. There was some debate, both within the SEC and without, over whether the changes outlined above should have taken the form of an interim final rule instead of a proposal. Several of the SEC commissioners who voted for the proposal urged the SEC staff to have the rule changes ready to enact by the end of 2012. The SEC will seek public comment on the proposed rules for 30 days.