On October 15, 2012, the Investor Advisory Committee (the “IAC”), which was established by the Dodd- Frank Act to advise the SEC on various regulatory and policy issues, submitted recommendations to the SEC on the SEC’s proposed rule to permit general solicitation and general advertising in private offerings made in reliance on Rule 506 of Regulation D of the Securities Act of 1933 (the “Securities Act”). The SEC’s proposed rule to eliminate the general solicitation ban is mandated by Section 201(a) of the Jumpstart Our Business Startups Act (the “JOBS Act”). For a discussion of the SEC’s proposed rule, including implications for investment advisers, please see the September 4, 2012 Davis Polk Client Newsflash, SEC Issues Proposal to Eliminate General Solicitation Ban as Mandated by the JOBS Act.

The IAC’s submission to the SEC included the following seven recommendations:

  • As a precondition to claiming the new general solicitation exemption, issuers should be required to file either a new “Form GS” or a revised version of Form D that would include, among other things, information about the issuer’s control persons, the issuer’s business and intended use of proceeds, the issuer’s counsel, auditors and accountants (if any) and a description of the issuer’s plans to use general solicitation. 
  • Issuers should be required to submit to the SEC, prior to or promptly after first use, all materials used in a general solicitation for a Rule 506 offering, including any print, audio or video content. The IAC also recommended that such material be made available to the public so that the public may inform the SEC of potential instances of fraud by issuers. 
  • The SEC should adopt a safe harbor establishing “clear and enforceable standards” for issuers to verify accredited investor status in Rule 506 offerings using general solicitation, including standards relating to verification by reliable third parties such as a broker-dealer, bank or licensed accountant. Under the SEC’s proposed rule, an issuer using general solicitation in a Rule 506 offering must take “reasonable steps” based on the “facts and circumstances” of the transaction to verify that the purchasers of the issuer’s securities are accredited investors, but the proposed rule does not provide specific measures that an issuer must take to verify a purchaser’s accredited investor status or otherwise provide a bright line test for determining what constitutes “reasonable steps.”
  • The SEC should make the filing of a Form D a condition for relying on the Regulation D exemption in order to encourage “broad compliance” with the filing requirement, but should consider “not impos[ing] undue penalties for inadvertent violations by small, unsophisticated issuers.” Currently, the filing of a Form D is required, but it is not a condition for relying on the Regulation D exemption. 
  • The SEC should take steps to ensure that any performance claims in materials used in general solicitations are based on a “clear, well-defined, and auditable standard.”
  • The SEC should amend the accredited investor definition as it relates to natural persons to better reflect a person’s financial sophistication. The current definition for natural persons relies exclusively on net worth and income tests that, according to the IAC, do not adequately address an investor’s actual investment sophistication. While the IAC acknowledged that the net worth component of the accredited investor definition cannot be amended until 2014 (pursuant to the Dodd-Frank Act), the IAC indicated that the SEC has the authority to otherwise amend the definition.
  • The SEC should promptly adopt the “bad actor” rule that it proposed in May 2011 that would disqualify securities offerings involving certain felons and other bad actors from relying on the exemption provided by Rule 506 of Regulation D. For further details on the SEC’s proposed “bad actor” rule, please see the June 10, 2011 Investment Management Regulatory Update.  

Notably, a number of state securities regulators and industry associations have submitted comment letters also requesting that the SEC establish a safe harbor for verifying accredited investor status in lieu of the proposed “facts and circumstances” regime.

We will continue to monitor developments.