The Jumpstart Our Business Startups Act (JOBS Act) directs the Securities and Exchange Commission (SEC) to eliminate the current prohibition against general solicitation and general advertising in certain securities offerings pursuant to Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933, as amended (Securities Act).
The JOBS Act provides that, in offerings under Rule 506 that involve general solicitation, sales must be limited to accredited investors and the issuer must take reasonable steps to verify that the purchaser is in fact an accredited investor. In the case of Rule 144A offerings, sales must be limited to those persons that the seller reasonably believes are qualified institutional buyers. On August 29, 2012, the SEC proposed rules to implement the JOBS Act mandate.
Rule 506 exempts from the registration requirements of the Securities Act transactions that do not involve a public offering. Currently, Rule 506 permits an issuer to offer and sell securities to accredited investors and to a limited number of non-accredited investors as long as, among other requirements, the issuer refrains from offering or selling such securities through any form of general solicitation.
The proposed rules provide that an issuer may engage in a general solicitation if
- The issuer takes “reasonable steps” to verify that the purchaser is accredited;
- All purchasers are accredited (either because the purchaser actually qualifies as an accredited investor or because the issuer reasonably believes that the purchaser qualifies as an accredited investor at the time of the sale)
- All other applicable conditions in Regulation D are satisfied
The key factor in satisfying the conditions necessary to engage in a general solicitation is the requirement that the issuer take reasonable steps to verify that the purchaser is accredited. Offerees need not be accredited investors, which is why an issuer can advertise its offering in a broad medium such as a newspaper advertisement. The focus, when an issuer engages in a general solicitation, is on whether the purchasers are accredited.
The SEC was clear in the proposed rules that the determination of whether the steps taken to verify an investor’s status are reasonable is based on the specific facts and circumstances of the particular investor and the transaction. The SEC therefore did not propose a specific test or a finite list of considerations. Rather, the SEC would require that the issuer consider a number of factors. As examples, the SEC suggests issuers consider the nature of the purchaser, the amount and type of information available about the purchaser, and the nature of the offering.
Nature of the Purchaser. Steps that would be reasonable vary depending on the type of accredited investor the purchaser claims to be. Some purchasers qualify as accredited investors because of their status, such as being a registered broker-dealer or a registered investment company. Other purchasers qualify as accredited investors because of a combination of their status and the amount of their total assets, such as a government-sponsored employee benefit plan with assets greater than $5 million, or a 501(c)(3) organization with assets greater than $5 million. Natural persons may qualify as accredited investors based on their net worth or income. The SEC recognized that verifying the accredited investor status of natural persons could pose practical difficulties (including those arising from legitimate privacy concerns by prospective purchasers) not present in the verification efforts regarding other kinds of accredited investors.
Information about the Purchaser. The amount and type of information that an issuer reviews is critical in determining what additional steps, if any, are necessary to verify a purchaser’s status. The SEC described a sliding-scale approach regarding what information would suffice in reviewing investor status. The more information an issuer has showing that a prospective purchaser is an accredited investor, the fewer steps the issuer would have to take to verify the investor’s status. Examples of the types of information to review include: publicly available information in regulatory filings (such as a public filing indicating a prospective purchaser is an executive officer of a registrant or an organization’s Form 990 filed with the IRS showing that the organization has the requisite amount of total assets); third-party information (such as a W-2 and publications disclosing the average compensation in the industry and at the place of work of a prospective purchaser); and verification by a third party (such as a broker-dealer, attorney, or accountant).
Nature and Terms of the Offering. The nature or means through which the issuer publicly solicits purchasers can be relevant to determining whether reasonable steps have been taken to verify accredited investor status. For example, in the case of an offering via a publicly accessible website, a mere “check the box” representation that they are accredited investors would not suffice as reasonable steps by the issuer, whereas an offering via a database (created and maintained by a reliable third party) of prescreened investors might suffice as reasonable steps by the issuer. The terms of the offering, such as a minimum required investment, can also be relevant to determining whether reasonable steps have been taken to verify accredited investor status. Requiring a minimum investment – that is sufficiently high, required to be in cash, and that the issuer has confirmed has not been financed – could constitute reasonable steps.
Regardless of the factors considered, the SEC recommends that issuers retain adequate records to memorialize the steps taken in the verification process. The proposed rules also clarify that issuers may continue to comply with the “no general solicitation rules” and could sell to sophisticated non-accredited investors.
Because these rules were proposed by the SEC, and not issued as interim final rules as previously expected, the SEC is seeking comments. In her comments regarding the proposal, SEC Chairman Mary L. Schapiro recognized the “very real concerns about the potential impact of lifting the ban on general solicitation” and expressed her hope that the SEC would receive comments on the requirement that an issuer that uses general solicitation take reasonable steps to verify that all of the purchasers are accredited investors. The SEC is requesting comments on a number of areas, including whether the SEC should specify methods for verifying accredited investor status; if so, what kinds of methods should be specified; and whether such methods should be required or discretionary.
The JOBS Act directed the SEC to adopt amendments to Rule 506 and Rule 144A by July 4, 2012. The SEC staff previously stated that that time frame was unrealistic, particularly given the extensive rulemaking still required under the Dodd-Frank Act. Nevertheless, several commissioners expressed their disappointment that the deadline was not met and that, rather than passing the interim final rules as expected, they were approving proposed rules. Commissioner Luis A. Aguilar voted against the proposal, believing it “is not balanced and fails to address the acknowledged increased vulnerability of investors.” The SEC hopes to adopt final rules before the end of the year.