On Wednesday, June 10, 2013, the SEC approved amendments to Rule 506, Rule 144A and Form D to accommodate Section 201(a) of the JOBS Act, which requires the SEC to eliminate the prohibition against general solicitation and advertising in offerings made in reliance on Rule 506 and Rule 144A. These changes become effective sixty days from their publish date in the Federal Register. The proposed amendments were discussed in a Dow Lohnes SEC Bulletin published on August 31, 2012. The SEC also adopted additional changes to Rule 506 that prohibit certain “bad actors” from participating in Rule 506 offerings.

Amendments to Rule 506

Amended Rule 506 allows issuers to offer securities through general solicitation and advertising if they satisfy the following conditions: all terms and conditions in Rules 501, 502(a) and 502(d) must be satisfied; all purchasers must be accredited investors; and issuers must take reasonable steps to verify that the purchasers of the securities are accredited investors. The SEC believes that the process of verifying accredited investor status is an objective determination based on particular facts and circumstances. Accordingly, the SEC decided to keep the Rule text as “take reasonable steps to determine,” while providing a non-exclusive list of principles to aid in the determination. Issuers should consider:

  1. the nature of the purchaser and the type of accredited investor the purchaser claims to be;
  2. the amount and type of information that the issuer has about the purchaser; and
  3. the nature of the offering, including the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as minimum investment amount.

In addition, the SEC included a list of non-exclusive methods for verifying accredited investor status for natural persons, which will satisfy the requirement of Rule 506(c), unless the issuer or agent has knowledge that the person is not an accredited investor. These can be used instead of, or in addition to, the principle-based methods described above. These methods include:

  1. for accredited investor status based on income, reviewing copies of an IRS form that reports income and obtaining a written representation that the purchaser reasonably expects to continue to earn the necessary level of income in the current year;
  2. for accredited investor status based on net worth, reviewing bank statements, brokerage statements, third party appraisal reports and credit reports and obtaining a written representation that all liabilities necessary to make a net worth determination are disclosed;
  3. relying on verification that the purchaser’s accredited investor status has been determined in the last three months, by receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, attorney or a CPA that such person has taken reasonable steps to verify the purchaser's accredited status; and
  4. for accredited investors who have invested in an issuer’s Rule 506(b) offerings, an issuer may obtain a written certification from the purchaser that they are an accredited investor.

Issuers will have the burden of demonstrating that the offering is entitled to the exemption under Rule 506(c) and should make sure that adequate records are maintained as to how the accredited investor status was verified. The amendments to Rule 506 do not change Rule 506(b), which means that Rule 506 offerings may still be conducted without general solicitation and advertising, allowing the issuer to avoid the additional steps necessary to verify that a purchaser is an accredited investor. Issuers must indicate in a new box on Form D whether or not they are relying on general solicitation and advertising provisions of Rule 506.

It is important for issuers to remember that the elimination of the ban on solicitation and advertising only applies to a Rule 506 offering. Issuers relying on Section 4(a)(2) or other Regulation D exemptions for private offerings are still prohibited from general solicitation and advertising. Additionally, broker-dealers participating in Rule 506 offerings will still be subject to FINRA Rule 2210 regarding any public communications. Private funds may rely on Rule 506(c) while maintaining their exemption from registration under the Investment Company Act, due to Section 201(b) of the JOBS Act, which provides that offerings of securities using general solicitation and advertising under the exemption provided for in Rule 506(c) will not be deemed to be public offerings.

Amendment to Rule 144A

Similar to the changes in Rule 506, Rule 144A is being amended to allow general solicitation and advertising, so long as the actual purchasers are those that issuers reasonably believe to be qualified institutional buyers.

Bad Actors Prohibition

The SEC also approved amendments to Rule 506 to implement Section 926 of the JOBS Act, requiring the SEC to disqualify reliance on Rule 506 if “bad actors” participate in the offering. The persons that are covered by this rule include: the issuer, its predecessors and affiliated issuers; directors, officers, partners and managing members; 20 percent beneficial owners; promoters; investment managers and principals of pooled funds; and persons compensated for soliciting investors. An issuer may not rely on Rule 506 if one of these covered persons had one of the following disqualifying events:

  1. within the ten years prior to the sale, are convicted criminally in connection with the purchase or sale of a security, making a false filing with the SEC or arising out of conduct of financial intermediaries;
  2. within five years prior to the sale, have a court injunction or restraining order in connection with the purchase or sale of a security, making a false filing with the SEC or arising out of conduct of financial intermediaries;
  3. within ten years of the sale, have a final order from the CFTC, federal banking agencies, National Credit Union Administration, or state regulators of securities, banking, insurance, savings associations or credit unions, which bar the participant from engaging in that regulated activity or is based on fraud, manipulation or deceptive conduct;
  4. are subject to SEC disciplinary orders, SEC cease and desist orders, or SEC stop orders;
  5. are subject to suspension or expulsion from an SRO; or
  6. within the last five years, are subject to a U.S. Postal Services false representation order.

There is an exception from disqualification if the issuer can show it did not know, and in the exercise of reasonable care could not have known, that a covered person had a disqualifying event. While disqualification from reliance on Rule 506 only applies to disqualifying events occurring after the effective date of the Rule amendment, there is a mandatory disclosure requirement to investors for known matters that existed before the effective date of the Rule amendment.