At an open meeting of the U.S. Securities and Exchange Commission on July 10, 2013, the SEC voted 4 to 1 to adopt a new rule to remove the ban on general solicitation and general advertising in certain private securities offerings. The final rule will not be effective until 60 days following its publication in the Federal Register, which means that the new rule will become effective in mid-September 2013. Until the new rule becomes effective, issuers cannot use general solicitation and general advertising in private securities offerings.
The amendment to Rule 506 of Regulation D permits an issuer to engage in general solicitation and general advertising in Rule 506 offerings, provided that all purchasers are accredited investors and the issuer takes reasonable steps to verify the purchasers are accredited. Effectively, this means that non-accredited investors may not purchase securities offered through general solicitations. The SEC has not yet proposed rules on another aspect of the JOBS Act known as the "Crowdfunding Exemption," which may address this issue.
The amendment to Rule 506 also includes a non-exclusive list of methods to satisfy the verification requirement for purchasers who are natural persons. The amendment to Rule 144A provides that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers, provided the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are qualified institutional buyers. Also at its meeting on July 10, the SEC proposed new rules for private offerings that are intended to protect investors and enhance the SEC’s ability to gather information about the private placement market. We summarize the proposed amendments at the end of this publication.
We believe that the removal of the ban on general solicitation and general advertising in offerings conducted under new Rule 506(c) may have a substantial positive effect on capital raising in the U.S.
On August 29, 2012, the SEC proposed rule and form amendments to implement Section 201(a) of the JOBS Act. The comment period for the proposed rule and form amendments closed on October 5, 2012. The SEC received over 225 comment letters on the proposed rule, including comments from professional and trade associations, law firms, investment companies and investment advisers, members of Congress, state securities regulators, issuers, individuals and other interested parties.
Amendment to Rule 506
The SEC adopted Rule 506(c) as proposed, with one modification in response to numerous comments. Under new Rule 506(c), issuers may offer securities through means of general solicitation, provided they satisfy the following conditions:
- all terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied (e.g., the definition of accredited investor, integration and resales under Rule 144);
- all purchasers of securities must be accredited investors; and
- the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors.
Reasonable Steps to Verify Accredited Investor Status – General Rule
Under the new Rule 506(c), issuers must take reasonable steps to verify the accredited investor status of purchasers. Whether the steps taken are “reasonable” will be an objective determination by the issuer (or those acting on its behalf) in the context of the particular facts and circumstances of each purchaser and transaction. Among the factors that issuers should consider are:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be (e.g., registered broker-dealer, high net worth individual, investment company, bank, etc.);
- the amount and type of information that the issuer has about the purchaser (e.g., publicly available information in filings with a federal, state or local regulatory body and reliable third-party information); and
- the nature of the offering, such as 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.
Reasonable Steps to Verify Accredited Investor Status – Safe Harbor Methods
In response to many requests for prescribed methods of verification that would be deemed sufficient, the SEC also included a modification to proposed Rule 506(c) to provide four non-exclusive methods of verifying accredited investor status for natural persons. Issuers that use one of these verification methods will be deemed to have satisfied the verification requirement, provided the issuer or its agent has no knowledge that the purchaser is not accredited. Issuers are not required to use any of these methods. An issuer will be deemed to have satisfied the verification requirement in Rule 506(c) by using any of the following methods:
- for investors who claim to be accredited based on their income: reviewing copies of any Internal Revenue Service form that reports income (e.g., Form W-2, Form 1099, etc.) for the two most recent years, along with obtaining a written representation from the investor that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;
for investors who claim to be accredited based on their net worth: reviewing one or more of the following types of documentation, dated within the prior three months, and by obtaining a written representation from the investor that all liabilities necessary to make a determination of net worth have been disclosed:
- for assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties are deemed to be satisfactory; and
- for liabilities: a credit report from at least one of the nationwide consumer reporting agencies is required.
- for investors whose accredited status is confirmed by an independent professional: obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that the independent professional has taken reasonable steps to verify that the investor is an accredited investor within the prior three months and has determined that the investor is accredited; or
- for investors who have previously invested in the issuer as an accredited investor and who desire to invest in a new Rule 506(c) offering: if a natural person (a) invested as an accredited investor in a Rule 506(b) offering by the issuer before the effective date of Rule 506(c) and (b) remains an investor of the issuer, the issuer will be deemed to have satisfied the verification requirement in Rule 506(c) with respect to that investor by obtaining a certification from the investor at the time of sale that the investor qualifies as an accredited investor.
The SEC specifically noted in the adopting release that personally identifiable information such as Social Security Numbers can be redacted from the information provided to issuers.
Transition of Current Rule 506 Offerings to Rule 506(c) General Solicitation Offerings
In issuing its final rule, the SEC took care to address Rule 506 offerings commenced before the removal of the ban on general solicitation. In this situation, the issuer may choose to continue the offering after the effective date of the new rule under either Rule 506(b) or Rule 506(c). If an issuer chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales of securities that occurred before the effective date in reliance on Rule 506(b).
Continued Availability of Offerings Under Rule 506(b) Made Without General Solicitation
Issuers will continue to have the ability under Rule 506(b) to conduct Rule 506 offerings without using general solicitation. As the SEC noted in the proposed rule, offerings under existing Rule 506(b) represent an important source of capital for issuers of all sizes, and the SEC believes that “the continued availability of existing Rule 506(b) will be important for those issuers that either do not wish to engage in general solicitation in their Rule 506 offerings (and become subject to the requirement to take reasonable steps to verify the accredited investor status of purchasers) or wish to sell privately to non-accredited investors who meet Rule 506(b)’s sophistication requirements.”
General Solicitation Not Permitted in 4(a)(2) Offerings
The amendment to Rule 506 affects only Rule 506, and not Section 4(a)(2) offerings in general. Accordingly, even after the effective date of Rule 506(c), an issuer relying on Section 4(a)(2) outside of the Rule 506(c) exemption is prohibited from engaging in general solicitation and general advertising.
Specific Issues for Private Funds
The SEC notes that private funds, such as hedge funds, venture capital funds and private equity funds, frequently rely on Section 4(a)(2) and Rule 506 to offer and sell their interests. In doing so, private funds often rely on one of two exclusions from the definition of “investment company” under the Investment Company Act – Section 3(c)(1) and Section 3(c)(7) – which enables them to be excluded from substantially all of the regulatory provisions of the Investment Company Act. Private funds are precluded from relying on either of these two exclusions if they make a public offering of their securities.
The SEC has historically treated Rule 506 transactions as “non-public” offerings for purposes of Sections 3(c)(1) and 3(c)(7). In issuing its final rule, the SEC stated that private funds may engage in general solicitation in compliance with new Rule 506(c) without losing either of the exclusions under the Investment Company Act.
Amendment to Rule 144A
Section 201(a)(2) of the JOBS Act directs the SEC to revise Rule 144A(d)(1) under the Securities Act to provide that securities sold in reliance on Rule 144A may be offered to persons other than qualified institutional buyers, or QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a QIB.
As amended, Rule 144A(d)(1) will require only that the securities be sold to a QIB or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under this amendment, resales of securities pursuant to Rule 144A can be conducted using general solicitation, so long as the purchasers are limited in this manner.
New Proposal by the SEC to Amend the Private Offering Rules
In light of a significant number of comments on the proposed rule submitted by investor and consumer advocates/activists, as well as to enhance the SEC’s ability to assess development in the private placement market, the SEC at its open meeting on July 10, 2013 voted 3 to 2 to propose new rules that would, if adopted:
- require issuers that intend to engage in general solicitation as part of a Rule 506 offering to file the Form D at least 15 calendar days before engaging in general solicitation for the offering;
- require issuers, within 30 days of completing any Rule 506 offering (whether or not general solicitation was used), to update the information contained in the Form D and indicate that the offering has ended;
- require issuers to provide additional information about the issuer and the offering in the Form D;
- disqualify issuers from using Rule 506 for future offerings until one year has elapsed after the required Form D filings are made if they, or their predecessors or affiliates, failed to comply, within the past five years, with the Form D filing requirements for a Rule 506 offering;
- require issuers to include legends and disclosures in written general solicitation materials;
- require issuers to submit written general solicitation materials to the SEC no later than the date of first use; and
- apply to private funds the SEC’s existing guidance about misleading statements by investment companies.
The above proposals are subject to a 60-day comment period and are likely to draw comments from members of Congress, law firms, investor and consumer advocates and academics. The proposed rule may not be adopted, its ultimate form is uncertain if it is adopted and the timing of any adoption is impossible to predict. We will continue to monitor developments regarding this proposed rule.