On Wednesday, July 10, 2013, the Securities and Exchange Commission (“SEC”) held an open meeting during which it approved the following three items in connection with its mandate to implement certain rules under Section 201(a) of the Jumpstart Our Business Startups Act (“JOBS Act”) and Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”):
- final rule amendments to eliminate the prohibition against general solicitation and general advertising in certain securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) and Rule 144A under the Securities Act, as mandated by Section 201(a) of the JOBS Act1;
- final rule amendments to disqualify securities offerings involving certain felons and other “bad actors” from reliance on the exemption from Securities Act registration pursuant to Rule 506, as mandated by Section 926 of the Dodd-Frank Act2; and
- proposed rule amendments to Regulation D, Form D and Rule 156 under the Securities Act that are intended to enhance the SEC’s ability to evaluate changes in the private offering market and to address the development of practices in Rule 506 offerings3.
We will issue a separate client alert with additional details on the rule amendments. In the meanwhile, we note a number of key points below.
Eliminating the Prohibition on General Solicitation and General Advertising in Certain Offerings
The final rule amends Rule 506 to permit issuers to use general solicitation and general advertising to offer their securities, provided that (1) the issuer takes reasonable steps to verify that the investors are accredited investors and (2) all purchasers of the securities fall, or the issuer reasonably believes they fall, within one of the categories of persons that are “accredited investors” (as defined in Rule 501 of Regulation D) at the time of the sale of the securities. The final rule also permits securities offered pursuant to Rule 144A to be offered to persons other than qualified institutional buyers (“QIBs”), including by means of general solicitation, provided that the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe to be QIBs.
The determination of the reasonableness of the steps taken to verify an accredited investor requires an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each purchaser and transaction. The final rule includes a non-exclusive list of safe harbors that issuers may use to satisfy the verification requirement for individual investors, including: (1) reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation from the purchaser that he or she has a reasonable expectation of earning the necessary income in the current year; and (2) receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
While the SEC noted that it has carefully considered certain commenters’ concerns that private funds engaging in general solicitation may raise certain investor protection issues, the final rule does not place additional limitations on general solicitation by private funds. Noting that other commenters believe that additional measures regarding private fund advertising are not necessary because the antifraud provisions of the federal securities laws continue to apply, the SEC said it will monitor and study the development of private fund advertising and undertake a review to determine whether any further action is necessary.
Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings
Under the final rule, an issuer cannot rely on the Rule 506 exemption if the issuer or any other person covered by the rule has had a “disqualifying event.” Unlike the proposed rule, which would have applied to disqualifying events that occurred prior to the date of the adoption of the rule, the final rule applies only to disqualifying events that occur after the effective date of the final rule. However, issuers offering securities under Rule 506 are required to provide investors with written disclosure of disqualifying events that occurred prior to the effective date of the final rule. Under the final rule, disqualifying events apply to executive officers and to officers who participate in the offering; under the proposed rule, disqualifying events would have applied to any officer of the issuer or any officer of a person paid to solicit investors. Moreover, under the final rule, disqualifying events apply to beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power; under the proposed rule, disqualifying events would have applied to any beneficial owner of 10% or more of any class of the issuer’s securities. Finally, unlike the proposed rule which would not have covered investment managers to pooled investment funds, the final rule covers investment managers to pooled investment funds as well as their principals.
Proposing Amendments to Private Offering Rules
The proposed amendments to Regulation D would, among other things, disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering. The proposed amendments would also require the issuer to file a Form D at least 15 calendar days before engaging in general solicitation for an offering and within 30 days of completing an offering. Currently, an issuer is required to file a Form D no later than 15 calendar days after the first sale of securities in an offering. Issuers would also need to report additional information on the Form D, include certain legends and disclosures in written general solicitation materials, and submit written general solicitation materials to the SEC (which would not be available to the general public).
The rule amendments will have a significant impact on the private offering market. There will be greater flexibility for private fund managers to market their funds and speak to the media. At the same time, if the proposed amendments are adopted, private fund managers will need to file more information with the SEC. The final rules become effective 60 days after publication in the Federal Register. Comments on the proposed rule are due 60 days after publication in the Federal Register.