Proposes Additional Offering Rules Aimed at Protecting Investors
In April 2012, the Jumpstart Our Business Startups Act (JOBS Act) was signed into law. Among other things, the JOBS Act directed the SEC to remove the general solicitation and advertising restrictions on securities issued in reliance on Rule 506 of Regulation D and under Rule 144A.
On July 10, 2013, the SEC adopted final rules to implement the JOBS Act mandate to lift the solicitation ban. In addition, the SEC adopted final rules to implement the prohibition of “felons and other ‘bad actors’” from participating in Rule 506 offerings, as required by Section 926 of the Dodd-Frank Act. The rules become effective 60 days after publication in the Federal Register. In connection with the adoption of these final rules, the SEC also released proposed rules for comment which are intended to address investor protection concerns.
This Client Alert summarizes key aspects of these actions by the SEC.
General Solicitation Rules
In addition to its original provisions, amended Rule 506 includes a new subsection, which permits the use of general solicitation and advertising in securities offerings if:
- the issuer takes reasonable steps to verify that purchasers of the securities are accredited investors, as defined in Rule 501 of Regulation D; and
- (a) all purchasers of the securities qualify as an accredited investor; or (b) the issuer reasonably believes that each purchaser of the securities qualifies as an accredited investor.
An issuer must take reasonable steps to verify the status of each purchaser of securities, which will be an objective evaluation by the issuer. Such evaluation will be based on the facts and circumstances of each purchaser and the nature of the particular transaction.
In addition, the final rule includes a non-exclusive list of methods that may be used to satisfy the requirement that the issuer has verified the purchaser is an accredited investor. Some of those methods include:
- with respect to income: reviewing copies of a purchaser's tax returns or other applicable IRS forms for the past two years, together with a written representation of the purchaser that he or she has a reasonable expectation of reaching the necessary income threshold in the current year;
- with respect to net worth: reviewing (a) statements of accounts, tax assessments, appraisal reports issued by third parties, and (b) a consumer report from at least one of the nationwide consumer reporting agencies, together with a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed; or
- receipt by the issuer of a written confirmation of a purchaser's accredited investor status from a registered broker-dealer, SEC-registered investment adviser, attorney or certified public accountant. It should be noted that the third party providing this certification must take reasonable steps to verify the purchaser's status as an accredited investor and represent that reasonable steps have been taken in its written confirmation.
Notably, the SEC indicated that an issuer will not have satisfied the requirement to verify a purchaser's accredited investor status by relying solely on a representation by the purchaser in an investor questionnaire.
Form D has been revised to include a separate box that issuers must check if claiming the new Rule 506 exemption permitting general solicitation and advertising. As discussed further below, the SEC has also issued proposed rules for comment regarding additional changes to the content, filing requirements and consequences for failing to file a Form D in connection with a Regulation D offering.
In addition to the amendments to Rule 506, the SEC amended Rule 144A to provide that securities sold in accordance with Rule 144A can now be offered to all persons (not just qualified institutional buyers (QIBs)) so long as Rule 144A securities are only sold to QIBs or those reasonably believed by the seller to be QIBs. Rule 144A already specifies non-exclusive methods by which a seller may establish that an investor is a QIB; the amendments do not add any additional standards for such determination.
Is any issuer excluded from relying on Rule 506?
Yes, the SEC also adopted rules implementing a prohibition of “felons and other ‘bad actors’” from participating in Rule 506 offerings, as required by Section 926 of the Dodd-Frank Act. The rules provide that issuers are disqualified from relying on Rule 506 for offerings if the issuer or certain persons related to the issuer have been subject to a disqualifying event after the effective date of the rule.
Persons who may disqualify an issuer from relying on Rule 506 include directors and certain officers, general partners and managing members of the issuer, 20% beneficial owners of the issuer, promoters, investment managers and principals of pooled investment funds and paid solicitors (as well as their general partners, directors, officers and managing members).
"Disqualifying events" include certain criminal convictions, court injunctions, restraining orders, final orders, SEC disciplinary orders, cease-and-desist orders and stop orders, suspensions or expulsions from a self-regulatory organization and U.S. Postal Service false representation orders.
What if an issuer opts not to use general solicitation and advertising?
The amendments to Rule 506 do not affect its existing provisions. Therefore, issuers who are not using general solicitation and advertising may continue to conduct securities offerings by following the existing provisions of Rule 506.
Impact to Private Funds
Private funds that rely on Section 3(c)(1) or 3(c)(7) exemptions under the Investment Company Act of 1940 for sales to U.S. persons may take advantage of the amended Rule 506 and use general solicitation and advertising.
Additionally, the SEC confirmed in the adopting release that the use of general solicitation in connection with a Rule 506 or Rule 144A offering would not be a barrier to a concurrent offering by the issuer in an offshore transaction in reliance on Regulation S. That is, a U.S. offering using general solicitation and advertising will not impact an issuer’s offshore private offering in reliance on Regulation S (which prohibits directed selling efforts in the U.S.).
What's next under the SEC's proposed rules?
In response to concerns that investors might not be adequately protected under the new general solicitation rules, the SEC proposed for public comment broader revisions to Regulation D, Form D and Rule 156 aimed at enhancing the SEC’s ability to review developments in the private placement market in Rule 506 offerings. Specifically, among other things, the proposed rules would:
- require an issuer to file a notice of sale 15 days before the offering, as well as at the conclusion of the offering. (The current rule requires an issuer to file a Form D no later than 15 days after the first sale of securities in an offering.);
- require an issuer to provide additional information about itself and the offering such as identification of the issuer's website, expanded information on the issuer, the offered securities, types of investors in the offering, the use of proceeds, information on the types of general solicitation used and the methods used to verify the accredited investor status. (Currently, Form D requires identifying information about the company or fund selling the securities, related person, the relied upon exemption and other limited factual information about the issuer and offering);
- disqualify an issuer (and its affiliates) that does not comply with the Form D filing requirements from using the Rule 506 exemption in any new offering for a year after the required Form D filings are made; however, the proposal does include a cure period for late filing as well as the possibility of obtaining a waiver from SEC staff;
- require an issuer to include legends and disclosures in written general solicitation materials; and
- for a temporary period of two years, require an issuer to submit written general solicitation materials to the SEC, which materials would neither be available to the public nor filed via EDGAR.
The proposal also solicits comment on the definition of “accredited investor.”
Although aimed at investor protection, it remains unseen as to whether these new potential disclosure requirements could hamper the use of general solicitation in private offerings and the access to the capital markets the JOBS Act intended to provide. Comments on the proposing release are due on or before 60 days after publication in the Federal Register.