On July 10, 2013, the US Securities and Exchange Commission proposed amendments to Regulation D and Rule 156 under the Securities Act of 1933 and Form D – a Notice of Exempt Offerings of Securities.1 The proposed amendments are intended to allow the SEC to better evaluate the development of market practices in offerings of securities pursuant to Rule 506 of Regulation D and to address concerns that may arise in connection with allowing issuers to engage in general solicitations in offerings of securities made pursuant to Rule 506(c) of Regulation D.  

Issuers considering engaging in a general solicitation in reliance on new Rule 506(c)2 should also consider whether they are willing to be subject to the additional obligations that would be imposed on them if the rule proposals discussed in this Legal Update are adopted by the SEC.

In particular, the rule proposals would:  

  • Require the filing of a Form D in offerings of securities made pursuant to Rule 506(c) before the issuer engages in general solicitation;  
  • Require the filing of a closing amendment to Form D after the termination of any offering made pursuant to Rule 506;  
  • Require written general solicitation materials used in an offering of securities made pursuant to Rule 506(c) to include certain legends and other disclosures;  
  • Require written general solicitation materials used in an offering of securities made pursuant to Rule 506(c) to, on a temporary basis, be submitted to the SEC;  
  • Disqualify an issuer from relying on Rule 506 for future offerings of securities for one year if the issuer, or any predecessor or affiliate of the issuer, did not comply within the last five years with a Form D filing requirement in an offering of securities pursuant to Rule 506;  
  • Extend the antifraud guidance contained in Rule 156 to the sales literature used to sell interests in private funds (funds that rely on the exclusions from the definition of investment company as set forth in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940); and  
  • Require an issuer to include additional information in a Form D about offerings conducted in reliance on Regulation D. Comments on the proposals are due by September 23, 2013.  

Background  

Rule 506 of Regulation D provides a limited offering “safe harbor” exemption under Section 4(a)(2) of the Securities Act from registration of securities under the Securities Act. Rule 506(b) permits an unlimited dollar amount of securities to be sold to an unlimited number of accredited investors and up to 35 non-accredited investors, as long as specified conditions of that rule are met. On July 10, 2013, the SEC adopted new Rule 506(c) that eliminates the prohibition against general solicitation and general advertising in an offering of securities relying on Rule 506 provided that all purchasers in the offering are “accredited investors” and the issuer takes “reasonable steps to verify” that purchasers of the securities are accredited investors.

When adopting new Rule 506(c), the SEC noted that a number of persons raised concerns that the elimination of the prohibition on general solicitation in an offering of securities pursuant to new Rule 506(c) “would attract both accredited and non-accredited investors and could result in an increase in fraudulent activity in the Rule 506 market, as well as an increase in unlawful sales of securities to non-accredited investors.” Many of these persons recommended that a variety of additional changes be made to better protect investors. To better assess the impact that the SEC’s changes to Rule 506 will have on investor protection and capital formation, as well as to assist the enforcement efforts of federal and state regulators, the SEC has proposed a number of changes to Regulation D, Rule 156 and Form D.  

Proposed Changes  

RULE 503  

In order to allow state securities regulators and investors to more easily determine whether an issuer is attempting to comply with new Rule 506(c) as well as whether “bad actors” are participating in the offering, the SEC is proposing to amend Rule 503 of Regulation D to require that a Form D be filed at least 15 calendar days before commencing a general solicitation for an offering to be made in reliance on new Rule 506(c), referred to as an “Advance Form D,” as opposed to the current rule of no later than 15 calendar days after the date of first sale.  

The Advance Form D would be required to include the following information:  

  • Item 1. Basic identifying information on the issuer;  
  • Item 2. Information on the issuer’s principal place of business and contact information;
  • Item 3. Information on related persons;  
  • Item 4. Information on the issuer’s industry group;  
  • Item 6. Identification of the exemption or exemptions being claimed for the offering;  
  • Item 7. Indication of whether the filing is a new filing or an amendment;  
  • Item 9. Information on the type(s) of security to be offered, if known;  
  • Item 10. Indication of whether the offering is related to a business combination;  
  • Item 12. Information on persons receiving sales compensation, if known; and  
  • Item 16. Information on the use of proceeds from the offering.  

The remaining information3 would be required to be filed by an amendment to Form D within 15 calendar days after the date of first sale of securities in the offering.  

In addition, in order to enhance the flow of information to the SEC, other regulators and investors, the SEC is proposing to amend Rule 503 to require the filing of a final amendment to Form D within 30 calendar days after the termination of any offering conducted in reliance on Rule 506 whether after the final sale of securities in the offering or upon the issuer’s determination to abandon the offering.  

RULE 507  

The SEC is proposing to amend Rule 507 of Regulation D to automatically disqualify an issuer from using Rule 506 in any new offering for one year if the issuer, or any predecessor of affiliate of the issuer, did not comply, within the past five years, with a Form D filing requirement in a Rule 506 offering. The one-year period would commence following the filing of all required Form D filings. Disqualification would occur only in connection with noncompliance with the proposed requirement that occurred after effectiveness of the proposed rule. Any noncompliance that occurred before effectiveness would not be a disqualifying factor.

The SEC has also proposed a 30-day cure period in connection with an issuer’s first failure to file timely a Form D or Form D amendment in connection with a particular offering. If the filing is made during this cure period, the issuer will be treated as having timely filed the Form D or Form D amendment.  

The SEC is also proposing to create a waiver process whereby disqualification may be waived by the SEC if the SEC determines “upon a showing of good cause, that it is not necessary under the circumstances that exemption be denied.” As examples, the SEC noted that, as with the waiver provision included in the “bad actor” rules applicable to Rule 506 offerings adopted by the SEC on July 10, 2012,4 a waiver may be appropriate if an issuer can show that the persons who controlled the issuer at the time of the failure no longer exercise influence over it or, if curing the failure is impossible, and good cause can otherwise be shown, that it is not necessary in the circumstances to deny the exemption.  

In addition, the SEC is proposing to amend Rule 507 to disqualify any issuer from relying on Rule 506 if the issuer, or any of its predecessors or affiliates, has been subject to any order, judgment or court decree enjoining the person for failure to comply with either proposed Rule 509 or proposed Rule 510T, each discussed below.  

RULE 509  

The SEC is proposing to add new Rule 509 to Regulation D requiring all issuers to include legends in any written general solicitation materials used in an offering of securities made in reliance on new Rule 506(c) and additional disclosures for private funds if any written general solicitation materials include performance data.  

The proposed disclosures are designed to inform potential investors as to whether they are qualified to participate in the offering, the type of offering being conducted and certain potential risks associated with the offerings.  

In particular, any issuer making an offer in reliance on new Rule 506(c) will need to include prominent legends in all written general solicitation materials to the effect that:  

  • The securities may be sold only to accredited investors, which for natural persons are investors who meet certain minimum annual income or net worth thresholds;  
  • The securities are being offered in reliance on an exemption from the registration requirements of the Securities Act and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act;  
  • The SEC has not passed upon the merits of or given its approval to the securities, the terms of the offering, or the accuracy or completeness of any offering materials;  
  • The securities are subject to legal restrictions on transfer and resale and investors should not assume they will be able resell their securities; and  
  • Investing in securities involves risk, and investors should be able to bear the loss of their investment.  

With respect to private funds issuing securities in reliance on new Rule 506(c), the SEC is proposing that an additional legend and disclosures be included in written general solicitation materials. The additional legend will require issuers to include disclosure to the effect that the securities offered are not subject to the protections of the Investment Company Act.  

In addition, the SEC is proposing to require that private funds that include performance data in any written general solicitation materials also include disclosures similar to that required by Rule 482 under the Securities Act for advertisements and other sales material of registered investment companies. In particular, issuers would be required to include:

  • A legend disclosing that:
    • Performance data represents past performance;  
    • Past performance does not guarantee future results;  
    • Current performance may be lower or higher than the performance data presented;  
    • The private fund is not required by law to follow any standard methodology when calculating and representing performance data; and  
    • The performance of the fund may not be directly comparable to the performance of other private or registered funds;  
  • Either a telephone number or a website where an investor can obtain current performance data (i.e., data as of the last date on which the private fund determined the valuation of its portfolio securities);  
  • Performance data as of the most recent practicable date considering the type of private fund and media through which the data will be conveyed;  
  • The period for which performance is presented; and  
  • Disclosure that fees and expenses have not been deducted in calculating performance data if that is the case, and that, if such fees and expenses had been deducted, performance may have been lower.  

RULE 510T  

The SEC is proposing new temporary Rule 510T to require that an issuer making an offering in reliance on new Rule 506(c) submit to the SEC any written general solicitation materials prepared by or on behalf of the issuer and used in connection with the offering. The written materials would be required to be submitted to the SEC no later than the date of first use of the materials. Proposed Rule 510T would expire two years after its effective date.  

The written general solicitation materials would be required to be submitted to the SEC through an intake page on the SEC website. Materials submitted to the SEC on the intake page will not be publicly available, but will used by the SEC to further its understanding of market practice. The intake page on the SEC’s website will be available upon effectiveness of new Rule 506(c) and issuers can, although they are not required to, use it, should they so choose, to voluntarily submit material to the SEC prior to the adoption and effectiveness of proposed Rule 510T.  

RULE 156

Rule 156 provides guidance on the types of information in investment company sales literature that could be misleading for purposes of the federal securities laws. Rule 156 provides interpretive guidance in certain areas which, based on the SEC’s experience with investment company sales literature, had proven to be particularly susceptible to misleading statements. The SEC is proposing to amend Rule 156 to extend the guidance in that rule to sales literature of all private funds, including private funds engaged in a general solicitation under new Rule 506(c).  

FORM D  

In order to enable the SEC to gather additional information on the use of Rule 506 and to assist the SEC in evaluating the impact of new Rule 506(c) on the existing Rule 506 market, the SEC is proposing to make the following changes to Form D:  

  • Item 2 would be revised to also require the identification of the issuer’s publicly accessible website address, if any, in connection with all offerings relying on Regulation D;  
  • Item 3 would be revised to also require, when the issuer is conducting an offering in reliance on new Rule 506(c), the name and address of any person who directly or indirectly controls the issuer, in addition to the information currently required for “related persons”;
  • Item 4 would be revised to also require the issuer to fill in a clarification field if the issuer checks the “Other” box when identifying its industry group, in connection with all offerings relying on Regulation D;  
  • Item 5 would be revised to replace the current “Decline to Disclose” a revenue range or net asset value range option with a “Not Available to Public” Option, which will only be available to a company that does not include information about its revenues, or a hedge fund or other investment fund that does not include information about its net asset value, in general solicitation materials, or that does not otherwise make the information publicly available; all other issuers will be required to disclose that information in connection with all offerings relying on Regulation D;  
  • Item 7 would be revised to also require the issuer to indicate whether it is filing an Advance Form D, in connection with an offering being made in reliance on new Rule 506(c), or a closing Form D amendment, in connection with any offering being made in reliance on Rule 506;  
  • Item 9 would be revised to also require the issuer to provide information, to the extent applicable, on the trading symbol and a generally available security identifier for the offered securities, in connection with all offerings being made in reliance on Regulation D;  
  • Item 14 would be revised to also require the issuer to provide information on the number of accredited investors and non-accredited investors that have purchased in the offering, whether they are natural persons or legal entities and the amount raised from each category of investor, in connection with all offerings being made in reliance on Rule 506;  
  • Item 16 would be revised to also require the issuer to provide information on the percentage of offering proceeds that were or will be used: (1) to repurchase or retire the issuer’s existing securities, (2) to pay offering expenses, (3) to acquire assets, otherwise than in the ordinary course of business, (4) to finance acquisitions of other businesses, (5) for working capital, and (6) to discharge indebtedness, in connection with all offerings made in reliance on Rule 506 by issuers that are not pooled investment funds (as used in Form D);  
  • Item 17 would be added to require the issuer to disclose the number and types of accredited investors that purchased securities in the offering (e.g., natural persons who qualified as accredited investors on the basis of net income or net worth) in connection with all offerings made in reliance on Rule 506;  
  • Item 18 would be added to require the issuer to disclose if a class of securities is traded on a national securities exchange, alternative trading system or any other organized trading venue, and/or is registered under the Securities Exchange Act of 1934, the name of the exchange, ATS or trading venue and/or the Exchange Act file number and whether the securities being offered are of the same class or convertible into or exercisable or exchangeable for that class, in connection with all offerings made in reliance on Rule 506;  
  • Item 19 would be added to require the issuer to disclose if the issuer used a registered broker-dealer in connection with the offering and whether any general solicitation materials were filed with the Financial Industry Regulatory Authority, in connection with all offerings made in reliance on Rule 506;  
  • Item 20 would be added to require an issuer that is a pooled investment fund advised by investment advisers registered with, or reporting as exempt reporting advisers to, the SEC, to disclose the name and SEC file number for each investment adviser who functions directly or indirectly as a promoter of the issuer, in connection with all offerings made in reliance on Rule 506;
  • Item 21 would be added to require the issuer to disclose the types of general solicitation used or to be used (e.g., mass mailings, emails, public websites, social media, print media and broadcast media) in connection with all offerings made in reliance on new Rule 506(c); and  
  • Item 22 would be added to require the issuer to disclose the methods used or to be used to verify accredited investor status in connection with all offerings made in reliance on new Rule 506(c).  

Additional Changes Possible  

In the proposing release, the SEC indicated that it had directed the staff to execute a comprehensive work plan upon the effectiveness of new Rule 506(c) to review and analyze the use of new Rule 506(c). Implementation of the work plan will assist the SEC in evaluating the development of market practices in offerings made in reliance on new Rule 506(c) and whether the SEC should consider additional changes related to new Rule 506(c), consistent with the SEC’s mission of protecting investors, maintaining fair, orderly and efficient markets and facilitating capital formation.