On July 10, 2013, the SEC adopted final rules to eliminate the long-standing prohibition on general solicitation and general advertising in connection with private securities offerings under Securities Act Rule 506 of Regulation D and Securities Act Rule 144A. The final rule’s elimination of the prohibition on general solicitation is required under Section 201 of the Jumpstart Our Business Startups Act, also known as the JOBS Act. By permitting general solicitations in private offerings, many issuers—including private funds—may find a wider base of potential investors, making it easier for these issuers to raise capital.
General Solicitation Offerings Under New Rule 506(c)
The SEC’s final rule, largely unchanged from the proposed rule issued on August 29, 2012, amends Rule 506 by including a new paragraph (c) to permit general solicitation in connection with a private offering if all purchasers in the Rule 506(c) offering are accredited investors and the issuer takes reasonable steps to verify that these purchasers meet the definition of an accredited investor. However, issuers conducting a general solicitation will not lose the benefit of the Rule 506(c) exemption if a purchaser is not an accredited investor, so long as the issuer has taken reasonable steps to verify the purchaser’s status and has a reasonable belief at the time of sale that the purchaser was an accredited investor.
Under the new rule, issuers in a Rule 506(c) general solicitation offering must take “reasonable steps to verify” that purchasers in the offering are accredited investors. The rule’s approach places an emphasis on the verification process itself and not just the results of that process. As the final rule’s adopting release makes clear, the verification process “is separate from and independent of the requirement that sales be limited to accredited investors, and [the requirement to conduct a reasonable verification process] must be satisfied even if all purchasers happened to be accredited investors.” However, Rule 506 offerings that are conducted without a general solicitation will not be subject to these new verification requirements and may still include up to 35 non-accredited investors in the offering. So, the “old” Rule 506 exemption continues unchanged as the Rule 506(b) exemption. Offerings under both parts of Rule 506 enjoy “covered security” status and therefore preemption of state blue sky laws.
Issuers should recognize that the elimination of the general solicitation prohibition only applies to offerings conducted in accordance with new Rule 506(c). Issuers conducting a private offering outside of the Rule 506(c) safe harbor are still restricted from engaging in making public communications to solicit investors.
Verification of Accredited Investor Status
To meet the requirements of Rule 506(c), an issuer’s verification process must be reasonable in light of the particular facts and circumstances of the offering. In making a determination as to reasonableness, the adopting release suggests that an issuer consider:
- The nature of the purchaser and the type of accredited investor the purchaser claims to be;
- The amount and type of information the issuer has on the purchaser; and
- The nature and terms of the offering, and the manner in which the purchaser was solicited.
For example, the adopting release notes that where the terms of an offering include a significant minimum investment requirement, an investor’s ability to satisfy this minimum “could be a relevant factor to the issuer’s evaluation of the types of steps that would be reasonable” to verify that investor’s accredited investor status.
In response to a number of comments to the proposed rule, the SEC created in the final rule some certainty for issuers conducting a Rule 506(c) offering by establishing four optional methods for verifying accredited investor status that, if used, will satisfy the verification requirements of Rule 506(c). These methods include:
- Reviewing IRS documentation showing an investor’s income and obtaining a written representation that the purchaser is likely to continue to meet the accredited investor income requirements;
- Reviewing copies of bank and brokerage statements and/or other financial records as evidence of the investor’s assets, and consumer credit reports as evidence of indebtedness, and obtaining a written representation from the investor that all indebtedness needed for the accredited investor determination has been disclosed;
- Obtaining written confirmation from a broker-dealer, registered investment adviser, attorney or CPA that such person has taken reasonable steps to verify the investor’s status as an accredited investor; and
- Issuers that previously conducted a Rule 506(b) offering and are now conducting a Rule 506(c) offering can relying on the written certification as to accredited investor status of an existing investor making a new investment in the Rule 506(c) offering.
Implications for Private Funds
For private investment funds relying on the exclusions from the Investment Company Act of 1940 (the 1940 Act) provided by Sections 3(c)(1) and 3(c)(7) of that act, the SEC confirmed in the adopting release that conducting a Rule 506(c) offering will not cause the fund to lose its exclusion under the 1940 Act, which prohibits such excluded issuers from making a public offering of its securities.
The final rule also amends Rule 144A to permit “offers” to be made through general solicitation to persons not meeting the definition of a “qualified institutional buyer” (QIB). However, even as amended, resales under Rule 144A can still only be made to a QIB (or to a person the seller reasonably believes to be a QIB).
Form D and Related Regulation D Releases
The final rule amends Form D to include a new box to check by issuers conducting a general solicitation Rule 506(c) offering. This change is in addition to certain other changes to Form D made in a companion release also issued on July 10. Finally, on the same day, the SEC issued a third release relating to Regulation D which implements the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the prohibition of the use of Rule 506 by “felons and other bad actors.” These two companion releases are summarized by clicking here.