On July 10, 2013, the U.S. Securities and Exchange Commission adopted significant amendments (PDF) to the private placement rules which will permit general solicitation and advertising in private placements under Rule 506, provided that issuers are not disqualified as “bad actors” and all the purchasers are accredited investors. The final rules will go into effect on Sept. 23, 2013, 60 days after their publication in the Federal Register.
With the passage of the Jumpstart Our Business Startups Act, or the JOBS Act, in April 2012, Congress directed the SEC to amend Rule 506 of Regulation D of the Securities Act of 1933, as amended, to lift the prohibition on general solicitation and general advertising on offers and sales under that rule. Previously, those seeking to raise capital through the sale of securities without registering with the SEC could not advertise that they were offering and selling securities.
The SEC addressed three major topics at its July 10 meeting:
- Adopted final rules to eliminate the prohibition on general solicitation and general advertising in private securities offerings under Rules 506 and 144A;
- Adopted final rules to make the Rule 506 exemption unavailable to “bad actors”; and
- Proposed rules that would require issuers to provide additional information about Rule 506 offerings which would allow the SEC to monitor the market now that the general solicitation and general advertising ban is lifted.
Rule 506. The SEC adopted amendments to Rule 506 as proposed, with the exception of one modification. That modification from the rule proposed on Aug. 29, 2012, was the inclusion of a nonexclusive list of methods that issuers may use to verify that an individual is an accredited investor. On the other hand, the amendments adopted as proposed create a new Rule 506(c), which will allow issuers to offer securities through general solicitation provided that they satisfy the following conditions:
- All purchasers must be accredited investors;
- The issuer must take reasonable steps to verify the purchasers are accredited investors; and
- All the terms and conditions of Rules 501, 502(a), and 502(d) must still be satisfied.
Accredited Investors. The existing accredited investor requirements will continue to apply to Rule 506(c). An individual qualifies as an accredited investor if the person has an individual net worth, or joint net worth with that person’s spouse, exceeding $1 million and not including the person’s primary residence; or if the person had an individual income in excess of $200,000, or joint income with that person’s spouse in excess of $300,000, for each of the two most recent years and a reasonable expectation of the same level of income for the current year. For the qualifications concerning investors other than natural persons, click here.
Reasonable Steps to Verify. Issuers using a Rule 506(c) exemption must take “reasonable steps to verify” that purchasers of the offered securities are accredited investors. This verification is its own separate requirement, so issuers should note that they must take reasonable steps to verify even if all the purchasers happen to be accredited investors. 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. The primary method of verification is the principles-based method, but the SEC also provided a nonexclusive list of four methods of verification for individuals in response to comments regarding the proposed rule.
Principles-Based Method of Verification. Under the facts and circumstances analysis, issuers should consider the following factors:
- The nature of the purchaser and the type of accredited investor the purchaser claims to be;
- The amount and type of information that the issuer has about the purchaser; 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.
Nonexclusive Methods of Verifying Accredited Investor Status for Individuals. In an addition to the proposed rule, the SEC also provided the following nonexclusive list of methods for verifying the accredited investor status of individuals:
- Income. An issuer may review IRS forms such as Form W-2, Form 1099, Schedule K-1 of Form 1065 and Form 1040 for the two most recent years and obtain a written representation from the purchaser that he reasonably expects to reach the income level necessary to qualify as an accredited investor for the current year.
- Net Worth. An issuer may review documentation such as bank statements, brokerage statements, certificates of deposit, tax assessments, appraisal reports by third parties, or a consumer credit report — all dated within the prior three months.
- Written Confirmation by Third Party. An issuer may obtain written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney or CPA that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months.
- Already Accredited. An issuer may obtain a certification from an individual purchaser certifying their accredited status if the purchaser invested as an accredited investor in the issuer’s offering prior to Rule 506(c).
It is important to note that this allowance of solicitation and advertising only applies to the new Rule 506(c) exemption. Therefore, issuers who use general solicitation and advertising are unlikely to be able to rely on Section 4(a)(2) (formerly Section 4(2)) as a fallback should the offering fail to comply with Rule 506(c) for whatever reason. Public advertising is still incompatible with a claim of exemption under Section 4(a)(2).
Rule 144A. Likewise, the SEC adopted amendments to Rule 144A which will allow securities sold under that rule to be offered to persons other than qualified institutional buyers, including by means of general solicitation, so long as the securities are only sold to persons that the seller reasonably believes to be a QIB. This amendment was adopted as proposed, but unlike the amendments to Rule 506, there is no requirement that reasonable steps be taken to verify QIB status.
Bad Actors. In a separate release (PDF) on July 10, 2013, the SEC also adopted amendments to Rule 506, as required under Section 926 of the Dodd-Frank Act, adding parts (d) and (e) to prohibit the use of the Rule 506 exemption by issuers who qualify as “bad actors.” The disqualification of bad actors here is “substantially similar” to the disqualification of bad actors in Regulation A of the Securities Act. Previously, Rule 506 did not impose a bad actor disqualification provision.
However, only disqualifying events occurring after Sept. 23, 2013 will disqualify an issuer from a Rule 506 exemption. Prior disqualifying events must still be disclosed to each purchaser under Rule 506(e). Furthermore, the issuer is required to exercise reasonable care in determining whether a disqualifying event exists under Rule 506(d).
Proposed Rules. Lastly, the SEC proposed amendments (PDF) to Regulation D, Form D and Rule 156 which are intended to address the agency’s concerns over the adoption of new Rule 506(c). Most notably, under these proposed amendments, issuers would be required to file Form D at least 15 days prior to using general solicitation in a Rule 506(c). Issuers would also have to file a closing amendment to Form D 30 days after the termination of the Rule 506(c) offering.
A proposed new Rule 509 would require issuers to include several new legends on any written general solicitation materials, and a proposed Rule 510T would require issuers to submit to the SEC any general solicitation materials used in a Rule 506(c) offering on or before the date such materials would first be used. These materials would not be made available to the general public.
The SEC also proposed amending Rule 156 to extend the sales literature anti-fraud guidance currently in the rule to sales of securities by private funds. Thus, information provided by a private fund to purchasers in a general solicitation under Rule 506(c) would be deemed sales literature under Rule 156.
OUR TAKE: While the lifting of the ban on general solicitation and advertising under Rule 506 is welcome news for issuers and investors alike, those seeking to use the new exemption must consider the significant steps that need to be taken in order to comply with Rule 506(c). In addition, the burdens imposed by the SEC’s proposed amendments to Regulation D, Form D and Rule 156 could limit issuers’ willingness to use the new Rule 506(c) exemption if those amendments are in fact adopted.