On July 10, 2013, the SEC adopted final rules1 implementing Section 201(a) of the Jumpstart Our Business Startups Act (the “JOBS Act”). These new rules eliminate the restriction on general solicitation in private securities offerings conducted pursuant to the safe harbor set forth in Rule 506 of Regulation D under the Securities Act of 1933, as amended (the “Securities Act”).
Under federal securities laws, a sale of securities must be made pursuant to an effective registration statement or in an unregistered offering in reliance on a specific exemption from registration. Rule 506 is a commonly used safe harbor that provides that an issuer may raise an unlimited amount of funds from sales of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. Generally, accredited investors are individuals that meet certain net worth or income requirements and entities that meet sophistication requirements. Prior to this recent rule change, Rule 506 prohibited the use of general solicitation or general advertising in connection with such offerings.
Under new Rule 506(c), an issuer may utilize general solicitation or general advertising in a Rule 506 offering, provided that (i) all purchasers of the securities are accredited investors (or persons that the issuer reasonably believes are accredited investors) and (ii) such issuers have taken reasonable steps to verify that the purchasers are accredited investors. Therefore, issuers may solicit any potential investors in connection with a private offering under Rule 506(c), as long as the ultimate purchasers are all accredited investors. The ban on general solicitation and general advertising has long been critical to private placement practice, and this ban remains in place for private securities offerings under Section 4(a)(2) of the Securities Act that do not fall under the specific safe harbor of new Rule 506(c). Issuers should note that, if they make a general solicitation in connection with a private placement under new Rule 506(c), they will not be able to rely on the more general private placement exemption of Section 4(a)(2). In the past, the general provisions of Section 4(a)(2) have served as a useful backstop to an inadvertent violation of Rule 506. Accordingly, issuers should carefully consider whether to engage in general solicitation or general advertising and forgo the ability to rely on the general private placement exemption.
Note that the verification requirement is independent from the requirement that all investors be accredited. That is, even if all investors happen to be accredited, an issuer must still take steps to verify such status. Whether particular verification methods are “reasonable” is an objective determination by the issuer, taking into account the facts and circumstances of each transaction and investor. To provide further guidance to issuers, the SEC provided a non-exclusive list of four methods that investors may use to satisfy the verification requirement:
- Reviewing copies of IRS forms that report income, such as a Form W-2 or Form 1099.
- Reviewing documentation such as bank statements, tax assessments, appraisal reports, and credit reports to determine the net worth of an individual, in addition to obtaining a written representation from such investor that all liabilities necessary to make a determination of net worth have been disclosed.
- Obtaining a written opinion from a registered brokerdealer, an SEC-registered investment advisor, a licensed attorney, or a certified public accountant that such person has taken reasonable steps to verify that the investor is accredited within the past three months and that such investor is in fact accredited.
- Any investor that participated in a Rule 506(b) offering prior to the effective date of the new rules, and remains an investor of the issuer, may provide a certification to the issuer that such investor remains accredited.
Failure to comply with all of the components of Rule 506(c), including the verification requirements (if there is general solicitation or general advertising), could result in rescission liability on the part of the issuer. Issuers should note that the verification requirement of Rule 506(c) does not apply in a Rule 506 offering if there is no general solicitation or general advertising. The SEC also enacted final rules amending Rule 144A under the Securities Act. Rule 144A provides an exemption from registration for the resale of securities to large institutional investors known as qualified institutional buyers (“QIBs”). The new rules modify Rule 144A so that offers of securities may now be made to investors that are not QIBs, as long as the securities ultimately are sold only to persons that the seller reasonably believes are QIBs. General solicitation and general advertising are now permitted in connection with resales of securities pursuant to Rule 144A, so long as the securities actually are sold only to QIBs or persons the seller reasonably believes to be QIBs.
In addition to the two rule changes described above, the SEC enacted final rules2 disqualifying felons and other “bad actors” from reliance on the Rule 506 safe harbor. The rule is made pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and provides that any issuer that has had a “disqualifying event” may not rely on Rule 506. “Disqualifying events” include criminal convictions, court injunctions, or restraining orders relating to the purchase or sale of securities. Certain SEC orders are also deemed to be disqualifying events.