On August 29, 2012, the U.S. Securities and Exchange Commission (“SEC”) proposed amendments to its rules that would allow securities issuers to solicit accredited investors by means of general solicitation and advertising in unregistered securities offerings made in reliance on Rule 506 of Regulation D. If adopted, the proposed amendments would implement the Congressional mandate contained in Title II of the Jumpstart Our Business Startups (JOBS) Act that the SEC amend Rule 506 of Regulation D to provide that the prohibition against general solicitation and advertising contained in Regulation D shall not apply to offers and sales of securities made pursuant to Rule 506, so long as all purchasers of the securities are accredited investors. The JOBS Act became law on April 5, 2012. You can read more about enactment of the JOBS Act in our earlier alert.
Rule 506 of Regulation D has long been the exemption of choice for companies and private investment funds conducting unregistered offerings. The rule permits the offer and sale of securities, without any limitation on the dollar amount, to an unlimited number of purchasers that the issuer reasonably believes are accredited investors—generally institutions and individuals who meet certain specified criteria, such as high net worth, indicating that they can fend for themselves without the protections of the securities laws—and up to 35 other persons who do not meet this standard but who have, or the issuer reasonably believes they have, such sophistication in financial and business matters that they are capable of evaluating the merits and risks of the prospective investment. Currently, Rule 506 offerings can not be conducted using any means of general solicitation or general advertising. According to SEC guidance, companies and private investment funds are limited to soliciting only potential investors with whom they have pre-existing substantive relationships. This prohibition has been interpreted to extend to cold calls and unrestricted website postings and, in certain situations, seminars pitching the investment. Elimination of the prohibition will permit issuers to reach a greater number of potential investors, without incurring the cost of registering their offerings with the SEC or state securities regulators or engaging financial intermediaries.
The Proposed Amendments
To implement the mandated rule change, the SEC proposes adding a new subsection (c) to Rule 506. This addition, coupled with other conforming amendments to Regulation D, would permit the use of general solicitation to offer and sell securities under Rule 506, provided the following conditions are met: (i) the issuer takes reasonable steps to verify that purchasers are accredited investors; (ii) all purchasers are accredited investors or the issuer reasonably believes they are all accredited investors; and (iii) all terms and conditions of certain existing Regulation D rules are satisfied. The amendments would retain the ability of an issuer to conduct a traditional private offering without general solicitation under existing Rule 506(b).
In lieu of permitting an investor to self-certify his, her or its qualification as an accredited investor, the JOBS Act conditions the public solicitation safe harbor for Rule 506 offerings on the issuer taking reasonable steps to verify that the purchasers are accredited investors “using such methods as determined by” the SEC. As such, Congress left to the SEC the difficult task of determining the appropriate level of issuer due diligence needed to strike a balance between fostering capital raising and job creation while also protecting unqualified investors. Despite this direction, the SEC decided against prescribing in its proposed amendments specific methods for verifying that purchasers are accredited investors. It also elected not to provide a non-exclusive list of verification methods that would satisfy the JOBS Act’s verification requirements. Instead, the SEC’s proposal mirrors the JOBS Act language, requiring issuers to take reasonable steps to verify accredited investor qualification as the facts and circumstances require in each offering. Issuers and their legal counsel are thus left with the task of determining the appropriate verification method that will satisfy this critical condition of the exemption with respect to any particular offering. Such an approach could make reliance on the exemption less certain with civil courts in investor brought actions being the ultimate determiners of whether the verification process used in a particular offering was reasonable.
The SEC provides scant guidance on what would be reasonable verification and in what contexts. In its release announcing its proposed amendments but not in the amendments themselves, the SEC discusses three factors that it believes should influence how issuers interpret the “reasonable steps” verification standard:
- The nature of the purchasers (i.e., verification steps would depend on whether the purchaser is accredited by virtue of its status, such as a registered broker-dealer, or by virtue of its financial position, such as an individual with high net worth or income).
- The information about the purchaser known by the issuer (i.e., the more an issuer knows about an investor, the fewer verification steps an issuer would be expected to take).
- The nature and terms of the offering (i.e., the more the offering is marketed to the general public, the more verification an issuer would be expected to conduct).
In a related action, the SEC also proposed amendments implementing another JOBS Act mandate that the SEC eliminate the advertising prohibition under Rule 144A.
The public may comment on the proposed amendments for 30 days. Given the level of non-partisan political pressure calling for the lifting of the solicitation ban, we expect that final amendments are likely to be adopted quickly after the comment period is completed.