On Aug. 29, 2012, the Securities and Exchange Commission (SEC) proposed long-awaited rules to eliminate the prohibition against general solicitation and advertising in securities offerings under Rule 506 of Regulation D and Rule 144A of the Securities Act. The proposed rules were adopted pursuant to the Jumpstart Our Business Startups (JOBS) Act passed in April of this year. The JOBS Act directed the SEC to amend Rule 506 to permit general solicitation and general advertising so long as all purchasers of the securities are accredited investors. The JOBS Act also directed the SEC to revise Rule 144A, which governs the resale of securities to large institutional investors known as “qualified institutional buyers” (QIBs), so that offers of securities could be made by means of general solicitation to investors who are not QIBs.
The elimination of the ban on general solicitation and advertising is expected to provide significant benefits to companies seeking to raise capital.
Rule 506 Accredited Investor Offerings
Under the proposed rules, companies issuing securities under Rule 506 would be permitted to use general solicitation and advertising to offer the securities if the following requirements are met:
- the issuer must take “reasonable steps” to verify that the purchasers of the securities are accredited investors; and
- all purchasers of the securities must be accredited investors who either (i) come within one of the categories of “accredited investor” under Rule 501(a) of Regulation D, or (ii) the issuer reasonably believes meets one of the accredited investor categories under Rule 501(a).
Contrary to what many practitioners and analysts expected, under the proposed rules the SEC did not mandate or specify any particular methods or steps to verify that purchasers are accredited investors (such as providing the investor’s tax returns or financial statements to the issuer). Rather, in determining the reasonableness of the steps an issuer takes to verify accredited investor status, issuers are to consider the facts and circumstances of each transaction, including the following factors:
- the type of purchaser and the type of accredited investor 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 (i.e., 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).
The SEC’s approach in making the verification process more subjective and based upon the facts and circumstances of each offering is expected to provide issuers more flexibility in determining whether to use general solicitation and advertising. At the same time, this subjective approach may present uncertainty to issuers who cannot be sure that their method of verification would be viewed as reasonable in the eyes of the SEC. Therefore, the proposed rules provide both great opportunity as well as a level of uncertainty.
The proposed rules would also preserve the existing portions of Rule 506 as a separate exemption, so that issuers could choose to conduct traditional accredited investor offerings without the use of general solicitation and advertising. Issuers using the existing exemption would not be subject to the verification rules described above.
Rule 144A Offerings
Under the proposed rules, securities sold pursuant to Rule 144A could be offered to persons other than QIBs by means of general solicitation and advertising, so long as the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe is a QIB.
The JOBS Act directed the SEC to adopt final rules on the elimination of the ban on general solicitation and advertising by July 4, 2012. The SEC failed to follow this mandate. Instead, the SEC missed this deadline and, when the SEC finally took action, it only adopted proposed rules and not final rules. The proposed rules are subject to a 30-day comment period, after which the SEC is expected to adopt final rules. It is uncertain when the SEC will adopt final rules and confidence is low that final rules will be adopted before 2013. In the meantime, general solicitation and advertising is still prohibited for all Regulation D securities offerings until the final rules are adopted.
When the final rules are adopted, the opportunity to engage in general solicitation and advertising is expected to allow issuers to reach a number of potential investors that they never would have been able to reach in the past. This is expected to substantially benefit capital formation activities.