On July 10, 2013, the Securities and Exchange Commission adopted amendments to Rule 506 of Regulation D to end the SEC's ban on general solicitations in certain private offerings, a ban that has been in place since the 1930s. The rule amendments were mandated by the JOBS Act, enacted in April 2012. Under the amended rule, companies will be allowed to conduct financings using print advertising, email solicitation, social media, website promotions, billboards or any other form of communication, provided all of the purchasers in the offering are "accredited investors" (generally, annual net income of at least $200,000 or net worth of at least $1 million). Although the lifting of the ban has attracted a fair amount of media coverage, much of the reporting left out several important facts regarding the rule changes and their usefulness. Below is a summary of what we believe to be the key facts regarding these rule amendments.
The rule amendments will not go into effect until September 2013 (or possibly later). The rule amendments are subject to a 60 day public comment period after being published in the Federal Register. Therefore, no company will be able to rely on these amendments and engage in a general solicitation at this time. The amendments have already generated some degree of controversy and it is possible that their implementation will be delayed further and that additional modifications will be made.
The rule amendments do not affect current offering practices for financings not involving a general solicitation. In its adopting release, the SEC made clear that it was not modifying the definition of general solicitation or the requirements that must be satisfied for any Rule 506 offering not utilizing a general solicitation. Therefore, a company wishing to avoid the new requirements under the rule amendments can choose to conduct its offering on the basis of existing rules.
The amended rule imposes much greater responsibility on the issuer to determine an investor's status as an accredited investor. Under new Rule 506(c) adopted as part of the rule amendments, issuers are required to take "reasonable steps to verify" the accredited investor status of purchasers. This requirement is significantly higher than the current standard that the issuer must only "reasonably believe" the purchasers are accredited investors. In offerings involving public solicitation or advertising, self certification by an investor will not be sufficient even if there is no reason to doubt the veracity of such certification. Rule 506(c) does identify four non-exclusive methods that would satisfy the verification requirement. These include utilizing publicly available information about an investor's income, reviewing copies of records of the investor such as a form W-2 or 1040, or receiving confirmation of accredited investor status from a third party such as a registered broker dealer, investment advisor, licensed attorney or certified public accountant. While some of the approaches suggested by the SEC may be feasible for particular offerings, they require the company as well as the investor to engage in much more cumbersome information gathering and record keeping than currently applies to Regulation D offerings. Until a streamlined process for compliance becomes more fully developed, many prospective investors may forgo investing in transactions that require disclosure of personal financial information.
The net worth test for accredited investors will be particularly difficult to satisfy. As noted above, there are a number of ways to verify someone's net income with a relatively high degree of confidence. This is less true in the case of net worth. While a company could relatively easily establish the value of an individual's total assets by examining bank or brokerage statements, there is no effective means of confirming an individual's total liabilities. In recognition of this, the SEC will permit investors to establish the amount of such liabilities through use of a credit report issued by a nationwide consumer reporting agency as well as a written confirmation by the purchaser of the absence of any other liabilities. Given the intrusiveness of this method of verification, it is likely that few investors will utilize it.
States securities filing burdens may be higher when using general solicitation. Many states, including Kentucky, provide an exemption from any filing requirements for certain offerings that do not involve any general solicitation or advertising. Unless these state laws are amended, these exemptions are likely to be unavailable for offerings conducted pursuant to the new SEC rules. This means that notice filings may need to be made—and associated filing fees may need to be paid—in each state in which any securities are sold.
The accredited investor status of existing investors in a company is not required to be verified. The SEC did provide one helpful exclusion to the verification procedure. Any existing investor in a company will only be required to re-certify their accredited investor status in a general solicitation offering and no further verification will be required.
SEC proposals could impose significant additional requirements on companies conducting offerings involving general solicitation.
In addition to the rules discussed above, which the SEC has adopted, the SEC has proposed for public comment certain new rules that, if adopted, would impose significant additional requirements on companies conducting offerings involving general solicitation. These proposals include:
- Pre- and post-filing requirements. Companies would be required to file a Form D at least 15 days in advance of the commencement of an offering, and file another Form D formally closing the offering within 30 calendar days following the offering's end;
- Additional information. Companies would be required to include on the Form D additional information about themselves and their offering, including the methods used to verify the accredited investor status of investors;
- Legend requirements. Companies would be required to include certain legends and disclosures in all written general solicitation materials; and
- Submission of offering materials to SEC. Companies would be required to submit to the SEC a copy of all written solicitation materials no later than the date of first use.
Failure to make the required Form D filings could result in the loss of the company's ability to conduct a private placement under Rule 506 (including offerings not involving a general solicitation) for a full 12 months.
The SEC also requested comment on whether to impose manner and content restrictions on offering materials.
Finally, and perhaps most significantly, the SEC indicated that it has begun to review the definition of "accredited investor", and is considering raising the standard for natural persons. The SEC has requested public comment on the accredited investor definition.
If adopted, these proposed rules would make it critical that a company monitor the general solicitation activities of its officers and promoters, and make sure that all general solicitation materials contain the required legends and are concurrently filed with the SEC.