On July 10, 2013, the Securities and Exchange Commission (the “SEC”) adopted a new rule to lift the ban on general solicitation for certain Rule 506 offerings to accredited investors. The new rule will become effective 60 days after publication in the Federal Register.
Rule 506 of Regulation D is the most popular private placement offering exemption available in the United States. One of the requirements to use this exemption has historically prevented companies relying on it from using general solicitation or general advertising to sell the securities. This ban on general solicitation has made it difficult for companies to find potential investors to raise capital.
The new rule allows a company to use general solicitation and general advertising in its private placement offering if (i) all purchasers of securities are accredited investors or the company reasonably believes that the purchasers are accredited investors (the “Accredited Investor Requirement”) and (ii) the company takes reasonable steps to verify that the purchasers are accredited investors (the “Verification Requirement”). The Verification Requirement is separate from and independent of the Accredited Investor Requirement, and must be satisfied even if all purchasers are accredited investors.
For natural persons, Regulation D defines an accredited investor as a person: (i) whose individual net worth, or joint net worth with that person’s spouse, exceeds US$1 million, excluding the value of the person’s primary residence (the “Net Worth Test”); or (ii) who had an individual income in excess of US$200,000 in each of the two most recent years, or joint income with that person’s spouse in excess of US$300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year (the “Income Test”).
The SEC has provided the following non-exclusive and non-mandatory methods of verifying that a purchaser who is a natural person is an accredited investor:
- For the Income Test, reviewing any IRS form that reports the purchaser’s income for the two most recent years (including Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;
- For the Net Worth Test, reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed:
- With respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
- with respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies;
- Obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor; and
- If any person purchased securities in a company’s Rule 506 offering as an accredited investor prior to the effective date of the new rule and continues to hold such securities, obtaining a certificate by such person at the time of sale that he or she qualifies as an accredited investor.
The new SEC rule does not affect the Rule 506 offering under the existing rules. Companies conducting Rule 506 offerings under the existing rules (i.e. without using general solicitation or general advertising) are not subject to the new verification rules.