The SEC yesterday:
- adopted final rules to repeal the ban on general solicitation in all Rule 144A offerings and certain Regulation D transactions, as required by Title II of the JOBS Act;
- adopted final rules to disqualify “bad actors” from participating in Regulation D Rule 506 offerings, as required by Section 926 of Dodd-Frank; and
proposed new Regulation D requirements. If adopted, the proposed rules would:
- impose filing requirements that could have a chilling effect on some market participants’ willingness to use general solicitation under new Rule 506(c); and
- effectively penalize an issuer for not filing a Form D in a Rule 506 offering. Issuers in many Rule 506 transactions today do not file a Form D.
We summarize the final and proposed rules below, and discuss our initial views on the impact that the proposed rules would have on current market practice.
General Solicitation Ban Repealed
The SEC adopted rules to implement Section 201(a) of the JOBS Act, repealing the ban on general solicitation in all Rule 144A offerings and certain Rule 506 transactions. The final rules are substantially similar to those proposed in August 2012, and will take effect 60 days from the date of publication in the Federal Register.
Under the new rules:
- General solicitation will be permitted in all Rule 144A transactions. Revised Rule 144A(d)(1) requires simply that securities must be sold – not offered and sold, as under current Rule 144A – only to QIBs or to purchasers that the seller and any person acting on behalf of the seller reasonably believe are QIBs. As a result, Rule 144A will be available even where general solicitation has occurred.
Rule 506(c) will permit general solicitation under certain conditions. New Rule 506(c) permits the use of general solicitation if:
- the issuer takes “reasonable steps to verify” that purchasers are accredited investors (AIs);
- all purchasers are AIs, either because they fall within the AI definition or the issuer reasonably believes that they do at the time of the sale; and
- all requirements of Rules 501 (definitions), 502(a) (integration) and 502(d) (resale restrictions) are met.
The “reasonable steps to verify” determination is left flexible. Whether verification steps are reasonable depends on facts and circumstances. The SEC suggested that some relevant factors include:
- the nature of the purchaser and the type of AI that 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.
There is a non-exclusive list of verification methods. The new rules include specific non-exclusive methods of verifying AI status. These include:
- when verifying whether an individual meets the AI income test, reviewing certain recent IRS forms and obtaining a written representation from the individual;
- when verifying whether an individual meets the AI net worth test, reviewing certain bank, brokerage and similar documents and obtaining a written representation from the individual; and
- obtaining written confirmation from an SEC registered broker-dealer or investment adviser, a licensed attorney or a CPA that has itself taken reasonable steps to verify that the purchaser is an AI.
- No general solicitation will be allowed in Section 4(a)(2) private placements. The rule changes affect only the Rule 506 safe harbor, not other private offerings under Section 4(a)(2) (formerly Section 4(2)). The SEC did not address private resales under Section 4(1½).
- Private investment funds will be able to engage in general solicitation. The SEC confirmed that privately offered pooled investment vehicles relying on the qualified purchaser (Section 3(c)(7)) or 100-holder (Section 3(c)(1)) exclusions under the Investment Company Act of 1940 may engage in general solicitation under Rule 506(c).
- Concurrent Regulation S offerings will not be affected. The SEC also confirmed that offshore offerings under Regulation S will not be integrated with concurrent Rule 506(c) or Rule 144A transactions. In other words, general solicitation will not constitute directed selling efforts that would jeopardize a concurrent Regulation S offering.
Bad Actor Disqualification Adopted
The SEC adopted rules to implement the ban of Section 926 of Dodd-Frank on the participation by “bad actors” in Rule 506 offerings, including offerings using general solicitation under new Rule 506(c). The rules take effect 60 days from the date of publication in the Federal Register.
Under the new rules, an issuer will not be able to rely on Rule 506 if certain individuals or entities (including directors and officers who participate in the offering) have been subject to a disqualifying event such as a conviction for securities fraud. Triggering events that occurred prior to the effectiveness of the new rules will not count, though they will be subject to mandatory disclosure. An issuer may nevertheless be able to rely on Rule 506 if it can demonstrate that it did not know and, in the exercise of reasonable care could not have known, that a disqualifying event existed.
The SEC proposed rules to expand the requirements of Regulation D. In particular, under the proposal:
- Form D information would need to be filed 15 days before engaging in general solicitation under Rule 506(c). Revised Rule 503 would require the filing of Form D information no later than 15 calendar days in advance of the first use of general solicitation in a Rule 506(c) offering.
- A “closing amendment” would need to be filed after terminating any Rule 506 offering. Revised Rule 503 would require the filing of a closing amendment to Form D within 30 calendar days after terminating any Rule 506 offering.
- Written general solicitation materials would include certain legends and disclosures. New Rule 509 would require prescribed legends in any general solicitation in written form in a Rule 506(c) offering. Private funds under the Investment Company Act would also be required to include an additional legend and certain disclosures.
- For the next two years, written general solicitation materials would need to be submitted to the SEC. New Rule 510T would require issuers to submit any written general solicitation materials used in Rule 506(c) offerings to the SEC no later than the date of first use of these materials. These submissions would not be available to the public, and Rule 510T would expire two years after its effective date.
- Failing to file a Form D would disqualify an issuer from relying on Rule 506. Revised Rule 507 would disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer or its affiliates did not comply, within the prior five years, with all the Form D filing requirements in a Rule 506 offering. The five-year period would not, however, extend to non-compliance that occurred prior to the effective date of the new rule.
What Impact Would the Proposals Have on Current Practice?
- Issuers will be more likely to make Form D filings. Issuers in many Rule 506 transactions today do not file a Form D, and filing the Form is not currently a condition to claiming the safe harbor. Revised Rule 507 could change that practice, since failure to file a Form D would result in disqualification from relying on Rule 506 in future offerings.
- The proposed advance filing and legending requirements could limit market participants’ willingness to engage in general solicitation in Rule 506(c) offerings. Current practices to prevent general solicitation are well understood by market participants. We are not certain that deal teams will find the new ability to generally solicit under Rule 506(c) attractive given the advance filing and legending requirements for written general solicitation materials.