As we have reported previously, on August 29, 2012, the SEC issued proposed revisions to Rule 506 under Regulation D of the Securities Act of 1933 (Rule) to accommodate the provisions under Title II of the Jumpstart Our Business Startups Act (JOBS Act). This legislation authorizes issuers to conduct general solicitation and advertising during a non-registered offering that will be sold exclusively to accredited investors.
In its proposal, the SEC failed to lay out how an issuer could comply with the Rule’s requirement to “take reasonable steps to verify” that each investor meets the accredited investor status at the time of purchase. According to some critics, the SEC’s failure to provide guidance or map out a “safe harbor” for the verification process will create uncertainty in the minds of issuers and regulators as to whether the verification process employed by the issuer was sufficient to meet the requirements of the revised Rule. Failure to comply with the verification requirement would likely result in the issuer violating the securities registration requirements under the Securities Act of 1933 and applicable state securities laws. Such failure would provide investors with a rescission right (i.e., require the issuer to buy back their securities at full purchase price plus interest from date of purchase at any time up to the applicable statute of limitations period) and provide securities regulators with a cause to bring enforcement action against the issuer, its principals, and other sellers of the securities.
This uncertainty, which is not expected by most observers to be addressed by the SEC in the final Rule, may cause issuers, who may have otherwise taken advantage of the elimination of the general solicitation and general provision prohibition, to continue under the existing Rule 506 until the ramifications of the verification uncertainty become more clear.
At their annual meeting in San Diego earlier this month, state securities regulators expressed reservations about the lack of SEC guidance within the revised Rule, and indicated they may quiz issuers who utilize general solicitation and general advertising and make a Form D filing with their states, to determine if the verification process utilized by the issuer was adequate. Without clear guidance from the SEC on the verification issue, what will likely result is a judgment call by each state securities regulator — and ultimately the courts — as to compliance with the verification requirement.
The uncertainty in this area also is likely to cause issuers to sell their offerings through registered broker-dealers who should already have policies and procedures in place to ensure that the investor meets the accredited investor standard. However, due to the shortage of registered broker-dealers who conduct private placement offerings, issuers may instead have to rely on advice from their legal counsel on what process should be implemented to protect against future claims that the verification process did not go far enough to meet the requirements under Title II of the JOBS Act. All in all, this uncertainty is not what Congress envisioned when it passed Title II of the JOBS Act.