Further Proposed Changes to Regulation D Private Placement Rules May Limit Benefits of the Revised Rules
As discussed in our firm memo dated August 6, 2013, the Securities and Exchange Commission issued new rules permitting general solicitation and general advertising1 in all Rule 144A and select Rule 506 offerings. As a result, issuers may begin to publicly market securities they intend to sell on a private basis, and offering participants need be less worried that an accidental mention of a contemplated offering during an earnings call or at an investor conference in response to a question may be found to constitute general solicitation, possibly resulting in the entire offering being deemed an unregistered public offering in violation of Section 5 of the Securities Act of 1933.2
In lieu of the previous focus on circumscribing the universe of individuals to whom unregistered securities could be offered or sold for a good private placement, the JOBS Act refocuses Rule 144A and creates a new Regulation D exemption focused solely on sales – the revised rules allow unregistered securities intended to be sold pursuant to Rule 144A or Rule 506(c) to be offered to anyone, provided all purchasers of such unregistered securities are “qualified institutional buyers” (“QIBs”) in the case of securities resold pursuant to Rule 144A or “accredited investors” (“AIs”) in the case of private placements under Rule 506(c).
On the same day that the final rules with respect to general solicitation and general advertising were published, the SEC released for comment a series of proposed rules that would apply to Regulation D offerings. Although the SEC indicated in a letter to the Chairman of the House Subcommittee on Oversight and Investigation of the Committee on Financial Services earlier this month that the proposed rules should not be seen to restrict the conduct of Regulation D offerings unless and until formally adopted (and that any new rules governing Regulation D private placements would provide for transition periods, so that offerings conducted in compliance with the currently-adopted rules prior to the effectiveness of any new rules would remain good private placements), as discussed below if the proposed rules were adopted they would take away some of the flexibility provided by the final rules with respect to general solicitation and general advertising and make issuers less likely to engage in Rule 506(c) offerings.
The revisions to Rule 144A apply to all Rule 144A offerings, and will have the greatest impact in the high yield debt markets. The revised rule allows for offers to be made, including by means of general solicitation or general advertising, to anyone, as long as the securities actually are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs. The procedures for verifying QIB status were not changed in connection with the revisions.
We note that Rule 144A is technically a resale exemption which permits initial purchasers to resell securities acquired from an issuer in a private placement exempt from registration under Section 4(a)(2) of the Securities Act, and as outlined in more detail below, 4(a)(2) private placements remain subject to the prohibitions on general solicitation. However, the SEC has affirmatively stated in a footnote to the adopting release that the general solicitation permitted in Rule 144A resales from the initial purchaser to the QIBs will not affect the availability of the Section 4(a)(2) exemption or Regulation S for the initial sale of the securities by the issuer to the initial purchaser.
The practical effect of the changes to Rule 144A remains to be seen. Changes will roll through each investment bank‟s form of purchase agreement (e.g., banks will need to modify their representations and warranties related to general solicitation). In addition, issuers will have flexibility to issue more fulsome press releases in private placements, absent the necessity to remain within the four corners of Rule 135c to craft a release that does not constitute an offer of securities. At a minimum, an issuer should be able to include the names of and contact information for the initial purchasers who are participating in the offering so that interested QIBs can request further information on the offering, including an offering memorandum. Finally, we believe that issuers, investment banks and their lawyers may become more relaxed about executives participating in investor conferences and other public events (e.g., press interviews) immediately before, during or after a 144A offering. Issuers may also elect to announce their intention to engage in private securities transactions during their earnings call. As always, issuers should be mindful that both Regulation FD and the general antifraud rules will apply in these situations.
The SEC‟s response to Congress‟ JOBS Act mandate was not to eliminate the prohibition against general solicitation under Regulation D wholesale, but instead to create a new Rule 506(c) that provides for sales not subject to the Rule 502 prohibition on general solicitation when sales are in fact made only to persons who are accredited investors (with the issuer required to take “reasonable steps to verify” purchasers are accredited investors).
Rule 506(c) provides for a principles-based method of verification of accredited investor status that looks at a variety of factors, including the nature of the purchaser, publicly and/or privately available information about the purchaser and the nature and terms of the securities offering. Whether an issuer has taken “reasonable steps to verify” that a purchaser is an accredited investor allowed to participate in the offering is a facts and circumstances test. The SEC specifically states that an issuer may rely on third-party verification if reliance is reasonable, and that if the purchaser has actual knowledge that an investor is an accredited investor, then no verification steps will be necessary. In all cases, the release emphasizes that the burden of proof to show that an offering is eligible for an exemption from registration will be on the issuer, so it is important for an issuer (or its agents) to keep records with respect to its accredited investor status verification procedures. However, a subsequent determination that a purchaser was not in fact an accredited investor at the time of its purchase will not be fatal to the exemption as long as the issuer‟s belief was reasonable.
Old Rule 506(b), which allows sales to be made to an unlimited number of accredited investors and up to 35 non-accredited investors (who meet certain sophistication requirements), and which does not require the verification procedures mandated for placements made in accordance with Rule 506(c)3, will still remain available to issuers, as will the ability to make an offer and sale that does not involve a public offering or distribution outside of the Regulation D safe harbor under Section 4(a)(2) of the Securities Act. However, the old prohibition on general solicitation will continue to apply to these transactions. Depending on the particular facts of its offering, an issuer should also consider whether it needs to comply with securities laws in jurisdictions outside the United States, and whether the presence of general solicitation or general advertising would violate private placement exemptions in such jurisdictions.
An issuer should keep in mind that once it elects to proceed with a Rule 506(c) private placement and begins engaging in activity that constitutes general solicitation or general advertising, it will be difficult if not impossible to reverse course, since an issuer generally can not avail itself of the other private placement safe harbors and Section 4(a)(2) once general solicitation or general advertising has occurred. Issuers are also cautioned that the general antifraud provisions of the U.S. securities laws will continue to apply to general solicitation and general advertising activities conducted as part of a Rule 506(c) offering, and will need to ensure that statements related to a private placement made in less formal settings are considered with the same seriousness and level of care as statements made as part of a roadshow or investor presentation.
Bad Actor Prohibitions
In connection with the JOBS Act amendments, the SEC also adopted rules to implement the “bad actor” prohibitions mandated by Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The bad actor rules prevent an issuer from using the Rule 506 safe harbors if “felons and other „bad actors‟” are participants in the offering.4 The list of persons participating in the offering for purposes of this rule is quite broad, and includes, among others, the issuer and any predecessor or affiliated issuer, its directors, its executive officers, other officers participating in the offering, promoters connected with the issuer in any capacity at the time of the securities offering, persons who will be engaging in solicitation in connection with the sale of securities and beneficial owners of 20% or more of the issuer‟s outstanding equity securities (calculated on the basis of voting power), as well as underwriters and placement agents. As a result of the comment process, only convictions and other triggering events that occur on or after the effective date of the amendments will disqualify a securities offering from use of the Rule 506 safe harbor, with pre-existing matters becoming subject to mandatory disclosure to potential investors. Rule 506(d) does include an exception from disqualification if the issuer establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed. In light of the new bad actor prohibitions, we recommend that issuers update their form of directors and officers questionnaires to ensure that they cover all of the items relevant for this analysis.
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At the same time as the SEC finalized the changes to its rules repealing the ban on general solicitation for certain private offerings, it published a proposing release with respect to a series of additional changes to the existing Regulation D framework. Whereas the rules effective on September 23, 2013 liberalize the private offering process consistent with the spirit of the JOBS Act, the newly proposed rules would provide for additional substantive and disclosure requirements in connection with Regulation D private placements.
If the proposals were to be enacted as drafted, an issuer would be required to:
- file an Advance Form D at least 15 calendar days prior to engaging in general solicitation in connection with a Rule 506(c) offering (a request with significant support from state securities regulators ), instead of 15 calendar days after the first sale of securities, as required by current Rule 503;
- file a closing amendment to a Form D within 30 calendar days following the closing of any Rule 506 offering (this would not be limited to Rule 506(c) offerings); and
- include specified legends and disclosures in written solicitation materials used in a Rule 506(c) offering.
In a significant departure from current law, the failure to comply with Form D filing requirements in a Rule 506 offering within the last five years by the issuer or any of its affiliates or predecessors would disqualify an issuer from relying on Rule 506 for one year following the date on which all required filings have been made. The SEC has also put out for comment proposed amendments to expand the level of disclosure on Form D. In particular, an issuer engaging in general solicitation as permitted by Rule 506(c) would be required to disclose the types of general solicitation used or to be used and the methods used or to be used to verify accredited investor status. So that the SEC is better able to monitor changes to the Rule 506 market as a result of the new changes in law, they have also proposed a new rule which would require issuers to provide the SEC with any written general solicitation materials used in Rule 506(c) offerings no later than the date of first use. The information would not be considered filed or furnished for purposes of the federal securities laws, and would not be made publicly available. As proposed, this rule would sunset after two years.
No Integration with Offshore Offerings
The SEC confirmed in the final adopting release that the general solicitation and general advertising now permitted for domestic unregistered offerings conducted in compliance with Rule 144A and Rule 506(c) should not constitute “directed selling efforts” that would cause an issuer to lose its exemption for offshore transactions otherwise conducted in accordance with Regulation S.
New and Proposed Changes to Rule 144A and Regulation D Offerings in a Nutshell What Securities Lawyers Need to Know
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