On April 5, 2012, the U.S. enacted the Jumpstart Our Business Startups Act (the "JOBS Act"), a series of regulatory reforms aimed at, among other things, easing the capital formation process in private offerings not requiring registration with the Securities and Exchange Commission (the "SEC"). Issuers privately placing securities in 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 have historically been prohibited from using general solicitation or general advertising to market their securities in offerings conducted under those rules.
Section 201(a) of the JOBS Act directed the SEC to amend its rules to remove the prohibition on general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 and Rule 144A, provided that (a) in the case of offerings pursuant to Rule 506 all purchasers of the securities are accredited investors and the issuer has taken reasonable steps to verify that all purchasers of the securities are accredited investors and (b) in the case of offerings pursuant to Rule 144A all purchasers of the securities are persons reasonably believed to be qualified institutional buyers ("QIBs").
On August 29, 2012, as mandated by the JOBS Act, the SEC proposed amendments to Rule 506 and Rule 144A under which domestic and foreign issuers would be permitted to use general solicitation and general advertising to solicit U.S. investors for either type of offering. The SEC seeks public comments on the proposed rules for 30 days following the date of their publication in the Federal Register. Following the review of comments, the SEC will determine whether to adopt the proposed rules.
Until the proposed rules are adopted by the SEC, the current ban on general solicitation and general advertising in private offerings under the Securities Act remains in effect. Once the proposed rules are adopted as proposed, issuers seeking to raise capital will be permitted to communicate information regarding private securities offerings to a expanded pool of potential U.S. investors.
The proposed rules are available at: http://www.sec.gov/rules/proposed/2012/33-9354.pdf.
Proposed Amendments to Rule 506
Removal of the Ban on General Solicitation and Advertising
Existing Rule 506 provides a “safe harbor” exemption from the registration requirements under the Securities Act for private placements by an issuer. Rule 506 allows an issuer to raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 other sophisticated persons conditioned in part on neither the issuer nor any person acting on its behalf making offers or sales by any form of general solicitation or general advertising. Under Rule 506, an accredited investor includes a person reasonably believed to be an accredited investor. The proposed amendment to Rule 506 would add a new and separate exemption, Rule 506(c), which would be available to an issuer that wishes to use general solicitation and general advertising to offer securities solely to accredited investors.
Under proposed Rule 506(c), an issuer would be permitted to utilize general solicitation or advertising in connection with a Rule 506 offering, provided that:
- the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors;
- at the time of the sale of the securities, all of the purchasers are, or the issuer reasonably believes them to be, accredited investors; and
- all terms and conditions of existing Rules 501 (definitions), 502(a) (integration restriction), 502(d) (resale limitations) and 503 (notice of sales) of Regulation D must be satisfied.
Reasonable Steps to Verify Accredited Investor Status
The proposed rules do not specify the methods that an issuer must use to verify that a purchaser is an accredited investor. The SEC noted that a prescriptive rule that specifies required verification methods could be overly burdensome in some cases, by requiring issuers to follow the same steps, regardless of their particular circumstances, and ineffective in others, by requiring steps that, in the particular circumstances, would not actually verify accredited investor status. Instead, the proposed rules provide that the determination whether steps taken are reasonable would be based on a case-by-case objective determination of the facts and circumstances of each transaction. To that end, the SEC provided a nonexclusive list of factors that an issuer should consider, including:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the issuer has about the purchaser; and
- the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering and the terms of the offering, such as a minimum investment amount.
The proposed rules note that these factors interact with each other. Thus, the stronger the support is under one factor indicating that a purchaser is an accredited investor, the fewer steps would be needed by the issuer to conclude that it has taken reasonable steps to verify the purchaser’s accredited investor status and vice versa. Possible verification techniques include (i) publicly available information with a local, state or federal regulatory body, (ii) third-party information, such as W-2s, that provides reasonably reliable evidence that a person is an accredited investor, or (iii) verification by a third-party, such as an accountant, attorney or broker-dealer, whom the issuer has a reasonable basis to rely upon.
As an example of application of these factors, the SEC noted that if an issuer solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation, the issuer would not have taken reasonable steps to verify accredited investor status if the issuer required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status. In contrast, the SEC acknowledged that if a minimum investment amount requirement is so high such that only accredited investors could reasonably be expected to meet it, then it may be reasonable for the issuer to take no steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by the issuer or by a third party.
No Changes to Reasonable Belief Standard
The SEC confirmed that, as part of its proposal, the “reasonable belief” standard incorporated in the current definition of accredited investor remains unchanged. Thus, in the event that an issuer sold securities in reliance on the new Rule 506(c) to a person who in fact was not an accredited investor, the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption for that offering, so long as the issuer reasonably believed that all purchasers were accredited investors under the existing standard and had taken reasonable steps to verify their status as required under the proposed rules.
Proposed Amendment to Form D
The proposed rules also amend Form D, which issuers must file with the SEC when they rely upon the exemption provided by Regulation D. The revised form would add a separate box for issuers to check if they are claiming the new Rule 506 exemption that would permit general solicitation and general advertising.
Private Offerings Without General Solicitation
While an issuer could make a Rule 506 offering using general solicitation or general advertising if the proposed rules are adopted as proposed, the SEC confirmed that the existing safe harbor for offerings not using any general solicitation or general advertising remains unchanged and remains available as is without the need to comply with the new verification requirement.
Proposed Amendments to Rule 144A
Existing Rule 144A provides an exemption from the registration requirements under the Securities Act by permitting the offer or sale of an unlimited amount of securities to an unlimited number of QIBs or to any person whom the seller and any person acting on behalf of the seller reasonably believes is a QIB. While existing Rule 144A does not specifically include a specific prohibition on general solicitation or general advertising, the existing requirement that any “offer” or “sale” be limited to QIBs has had the same practical effect. The SEC is proposing to amend Rule 144A to no longer require that an “offer” be made only to QIBs or any person reasonably believed to be a QIB. Instead, the proposed amendment to Rule 144A will exempt offers and sales made pursuant to the terms of the exemption as long as the only “sales” made are to QIBs or any person reasonably believed to be a QIB. This change has the effect of allowing general solicitation under Rule 144A so long as actual sales are limited to QIBs and any person whom the seller and any person acting on behalf of the seller reasonably believe to be a QIB.
No Integration with Concurrent Regulation S Offering
Issuers that conduct an offering pursuant to Rule 506 or Rule 144A often conduct a simultaneous offshore offering of the issuer’s securities in reliance on the exemption from registration provided by Regulation S, provided that the issuer has not engaged in any “directed selling efforts” in the United States. In the proposed rules, the SEC confirmed that, consistent with the historical treatment of concurrent Regulation S and Rule 506/Rule 144A offerings, concurrent offshore offerings that are conducted in compliance with Regulation S would not be integrated with domestic unregistered offerings that are conducted in compliance with amended Rules 506 or 144A.