As mandated by the JOBS Act, the SEC is proposing to permit the use of general solicitation and advertising (general advertising) for private securities offerings made in reliance on Rule 506 of Regulation D. Consistent with the JOBS Act, new Rule 506(c) would permit the use of general advertising, provided that: (1) the issuer takes “reasonable steps” to verify that the purchasers of the securities are accredited investors, and (2) all purchasers of securities are accredited investors (either because they come within one of the enumerated categories of accredited investors in Rule 501(a) or the issuer “reasonably believes” that they do, at the time of the sale of the securities). The SEC left alone Rule 506(b), thereby preserving the ability of issuers to conduct Rule 506 offerings without the use of general advertising to up to 35 non-accredited investors, in addition to an unlimited number of accredited investors.
Whether particular steps to verify accredited investor status are “reasonable” would be, according to the SEC, an “objective determination” based on the facts and circumstances of each transaction. Thus, issuers would have some flexibility to adopt different approaches to verification to suit their circumstances. The SEC anticipates that many current practices used by issuers in connection with Rule 506 offerings could satisfy the proposed verification requirement. The proposed Rule’s failure to prescribe specific methods of verification, however, has drawn sharp criticism from state securities administrators. The North American Securities Administrators Association, for example, has commented that the “lack of guidance in this area will lead to serious consequences – namely, litigation … . [E]ach state regulator will have to make an independent determination whether an issuer has taken reasonable steps to verify, and those determinations will ultimately be reviewed by judges across the country. The likely result is not only costly litigation but inconsistent interpretations.”
Consistent with the JOBS Act, the SEC reiterated its historical practice of regarding Rule 506 transactions as non-public offerings for purposes of the private fund exclusions of Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. Accordingly, privately offered funds could use general advertising under revised Rule 506, as proposed, without losing either of these exclusions.
The SEC, which already has missed the deadline that the JOBS Act imposed for these amendments, may seek to adopt a final rule promptly.