SEC to Permit General Solicitation and Advertising in Certain Private Securities Offerings
Corporate Services Law Update 08/07/13 Ryan P. Morrison, Mark T. Ehrmann, Joseph D. Masterson, Corbin J. Morris
- On September 23, 2013, the Securities and Exchange Commission's final Rule 506 offering amendments will take effect. These amendments lift the long-standing prohibition on general solicitation and general advertising for certain private securities offerings under Rule 506 of Regulation D ("Rule 506"); provided that:
- the issuer takes reasonable steps to verify that the investors are accredited investors; and
- all purchasers of the securities fall within one of the categories of persons who are accredited investors or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
- On September 23, 2013, the SEC's amended Rule 506 will also disqualify issuers and other market participants from relying on Rule 506 if "felons" or other "bad actors" participate in a Rule 506 offering (the "Bad Actor Rules"), including those who have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified federal and state laws.
- Finally, the SEC simultaneously proposed a series of additional revisions and new rules that impose further disclosure requirements on the issuer when the issuer intends to take advantage of the new general solicitation and advertisement rules, including filing both a pre-offering and post-offering Form D.
Securities offerings that comply with the safe harbor provisions of Rule 506 of Regulation D are exempt from the registration requirements of the Securities Act of 1933. Under existing Rule 506(b), an issuer may sell an unlimited amount of securities to an unlimited number of "accredited investors" and to no more than 35 non-accredited investors who meet specified "sophistication" requirements. However, Rule 506(b) is subject to, among others, Rule 502(c), which prohibits an issuer relying on the Rule 506 exemption from offering or selling securities through any form of "general solicitation or general advertising." While these terms are not defined in Rule 502(c), the rule does provide examples of general solicitation and general advertising, including advertisements published in a newspaper or magazine, communications broadcast over television or radio, and seminars or meetings whose attendees have been invited by a general solicitation or general advertising. Through no-action and other guidance, the SEC has also interpreted Rule 502(c) to prohibit the use of other publicly available media, such as unrestricted websites, to market private offerings.
The amendments to Rule 506 do not discard the existing registration exemption under Rule 506(b), but rather add another exemption under new paragraph 506(c). One of the trade-offs for allowing advertising and solicitation in Rule 506(c) offerings is that purchasers in such offerings are restricted to only accredited investors and require heightened diligence by issuers, as discussed in more detail below. Therefore, issuers that do not wish to advertise or solicit, or that wish to include a limited number of non-accredited investors who meet the sophistication requirements, may continue to rely on existing Rule 506(b). Such issuers should consider additional steps to verify accredited investor status if it is important in those offerings.
New Rule 506(c)
New Rule 506(c), enacted to implement Section 201(a) of the Jumpstart Our Business Startups Act, will allow issuers to engage in general solicitation and general advertising to market their offerings, so long as:
- all purchasers of the securities are accredited investors;
- the issuer takes "reasonable steps to verify" that the purchasers of the securities are accredited investors; and
- all terms and conditions of Rules 501, 502(a) and 502(d) are satisfied.
Verification of Accredited Investor Status
A central question for issuers who desire to take advantage of new Rule 506(c) immediately becomes, what constitutes "reasonable steps to verify" accredited investor status? Here, issuers have two options: (1) a "principles-based" approach or (2) using one of a list of non-exclusive methods of verifying accredited investor status.
Principles-Based Approach. Under the principles-based approach, whether the steps taken by the issuer to verify accredited investor status are "reasonable" will be an objective determination by the issuer in the context of the particular facts and circumstances of each purchaser and transaction. The adopting release to the Rule 506 amendments sets forth the following factors that an issuer should consider under the principles-based approach: (i) the nature of the purchaser and the type of accredited investor that the purchaser claims to be; (ii) the amount and type of information that the issuer has about the purchaser; and (iii) 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. The SEC has noted that these factors are interconnected and that the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer needs to take to verify that status. For example, if the minimum investment for an offering is sufficiently high such that only accredited investors could be expected to participate, then less verification of those investors would be required.
Non-Exclusive Methods. Recognizing that issuers may desire greater certainty that they satisfy the verification requirement with respect to individual (as opposed to entity) purchasers, the SEC included in Rule 506(c) a list of four non-exclusive methods that, if used, will satisfy the verification requirement:
- Income Verification - an issuer may review copies of any Internal Revenue Service form that reports income, including Form W-2, Form 1099, Schedule K-1 of Form 1065, and a filed Form 1040, for the two most recent years, along with obtaining a written representation from the individual that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year.
- Net Worth Verification - an issuer may review one or more of the following, dated within the prior three months: bank statements, brokerage statements, certificates of deposit, tax assessments, and appraisal reports issued by an independent third party (for assets); and a consumer credit report from at least one of the nationwide consumer reporting agencies (for liabilities). The issuer must also obtain a written representation from the individual that all liabilities necessary to make a determination of net worth have been disclosed.
- Third-Party Verification - an issuer may obtain a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that the confirming 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.
- Grandfathered Verification - with respect to any natural person who invested in an issuer's Rule 506(b) offering as an accredited investor prior to September 23, 2013, and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement in Rule 506(c) with respect to any such person by obtaining a certificate by such person at the time of sale that he or she qualifies as an accredited investor.
Notably, the requirement that the issuer take reasonable steps to verify that purchasers are accredited investors is separate and independent from the requirement that all purchasers in fact be accredited investors. Even when all purchasers are accredited investors, the issuer must still satisfy the verification requirement. For an on-going offering, an issuer may choose to continue the offering under either Rule 506(b) or Rule 506(c), and general advertisements or general solicitations made after the effective date of Rule 506(c) will not be deemed to violate the exemption for the pre-enactment Rule 506(b) offering.
Amended Rule 144A
In addition to the changes to Rule 506, the SEC also amended Rule 144A to provide that securities sold in accordance with Rule 144A can now be offered to all persons (not just qualified institutional buyers ("QIBs") so long as the securities are only sold to QIBs or those reasonably believed by the seller to be QIBs. Rule 144A already specifies non-exclusive methods by which a seller may establish that an investor is a QIB; therefore, the final rules do not add any additional standards for such determination.
Amendments to Form D Requirements
As part of the amendments to Rule 506, the SEC made revisions to Form D, the notice of an unregistered offering. New Form D will include a check box under Item 6 for an issuer to indicate that it is relying on the new Rule 506(c) exemption. Issuers must check a box either for 506(b) or 506(c) and therefore must determine at the outset which exemption they will rely on (with the limited exception of amending a continuing pre-Rule 506(c) offering to take advantage of the new rule after its effectiveness).
Bad Actor Rules
Concurrently with adopting the Rule 506 amendments, the SEC adopted the Bad Actor Rules, as mandated by Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Bad Actor Rules - additional amendments to Rule 506 - prohibit certain "felons" and "bad actors" from participating in Rule 506 offerings (under Rule 506(b) or Rule 506(c)). The disqualification will apply if the issuer or other covered persons (such as underwriters, placement agents, investment managers of pooled investment funds, and the directors, executive officers and certain other officers and large beneficial owners of the issuer) have been convicted of, or are subject to a court or administrative sanction for, securities fraud or other violations of specified federal and state laws. A person will be disqualified under the Bad Actor Rules only for triggering events that occur after the effective date of the rules.
SEC Proposed Rules
The SEC also issued proposed rules designed to allow the SEC to better monitor Rule 506 offerings and provide additional investor protection. These proposals include, among others:
- Amending Rule 503 of Regulation D to require (1) the filing of Form D at least 15 calendar days in advance of the first use of general solicitation in a Rule 506(c) offering and (2) the filing of a closing Form D amendment within 30 calendar days after the termination of a Rule 506 offering.
- Amending Form D to require additional information with regard to offerings that rely on Rule 506, including, if the offering relies on Rule 506(c), the methods used to verify accredited investor status.
- Amending Rule 507 of Regulation D to disqualify an issuer from relying on Rule 506 for one year if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years (but not prior to the effective date of the proposed rule), with all of the Form D filing requirements in a Rule 506 offering.
- Adopting new Rule 509, which would require issuers to include prescribed legends in any written communication that constitutes a general solicitation in any offering conducted in reliance on Rule 506(c), plus additional disclosure requirements for private fund issuers.
- Requiring private funds to comply with anti-fraud guidance under Rule 156 regarding sales literature, which previously only applied to public funds.
- Requiring issuers relying on Rule 506(c) to submit their written general solicitation materials to the SEC, on a temporary basis, no later than the first date on which such materials are used in the offering. The submitted materials would not be publicly available.
The SEC is seeking comments on the proposed rules, which must be submitted no later than September 23, 2013.
For more information on the Rule 506 amendments, Bad Actor Rules, and the proposed SEC rules, please contact Kathleen J. Swan at (312) 715-5015 / [email protected]; Ryan P. Morrison at (414) 277-5401 / [email protected]; Mark T. Ehrmann at (608) 283-2479 / [email protected]; Joseph D. Masterson at (414) 277-5169 / [email protected]; Geoffrey M. Ossias at (602) 229-5231 / [email protected], or your Quarles & Brady attorney.