Earlier this summer, together with some of my partners within DLA Piper (Christopher Paci, Jason Harmon, Darryl Steinhause and Wesley Nissen), I wrote an article about new SEC regulations concerning private offerings. The final rules issued in July 2013 by the SEC go into effect on September 23, 2013. Below is a summary of the changes with respect to general solicitation in such rules. The full article contains a discussion of other regulatory issues that should be considered and new “bad actor” rules, as well as a discussion of certain proposed private offering rule changes that are not yet final. That piece may be found here.
On July 10, 2013 the US Securities and Exchange Commission adopted much-anticipated amendments to its regulations on private offerings under Rule 506 of Regulation D of the Securities Act of 1933, as amended, that lift the more than 80-year ban on general solicitation and advertising for certain purchasers, as mandated by Section 201(a) of the Jumpstart Our Business Startups Act (popularly called the JOBS Act).
Beginning September 23, 2013, these changes will permit issuers to use advertising and other forms of mass communication to sell securities solely to “accredited investors” under Rule 506 of Regulation D. However, these amendments also include several new requirements and procedures. You will want to be aware of these changes before you launch a general solicitation campaign.
In addition to the rules on general solicitation, the SEC adopted rules disqualifying securities offerings involving certain “bad actors” from reliance on the Rule 506 exemption (regardless of whether general solicitation or general advertisement are utilized), as mandated by Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. You will find a detailed discussion of the new bad actor rules, also effective September 23, 2013, in the section entitled “‘BAD ACTOR’ DISQUALIFICATION IN PRIVATE PLACEMENTS“ in the longer article located here.
As mentioned above, on July 10, 2013, the SEC also proposed new rules for Rule 506 private offerings that, if adopted, will subject such offerings to additional procedures and requirements, including special requirements for offerings using general solicitation or general advertising. You will find a detailed discussion of the proposed additional general solicitation-related rules, which are not yet final and therefore not going into effect yet, in the section entitled “PROPOSED CHANGES TO FORM D, REGULATION D AND RULE 156 UNDER THE SECURITIES ACT” in the article found here.
FINAL RULES ALLOWING GENERAL SOLICITATION AND GENERAL ADVERTISING
Rule 506 of Regulation D provides issuers a “safe harbor” under Section 4(a)(2) of the Securities Act for sales of securities not involving any public offering. If issuers comply with the requirements of Rule 506, then they do not need to register the offered securities with the SEC or any state securities regulator and usually do not need to file reports with the SEC other than a Form D within 15 days of the first sale of a security under this exemption.
Under the Rule 506 exemption, now referred to as Rule 506(b), issuers may sell an unlimited amount of securities, provided that they comply with the following requirements:
- the issuer may not use general solicitation or general advertising
- the issuer may sell to an unlimited number of accredited investors, but only up to 35 other purchasers, who must themselves be sophisticated
- if non-accredited investors are included in the offering, the issuer must provide certain disclosures and financial information to them and
- the securities received are “restricted.”
The new amendments to Rule 506 add subsection (c) that permits an issuer relying on this exemption to engage in general solicitation or general advertising when offering and selling securities, provided that:
- all purchasers are accredited investors (or investors that the issuer reasonably believes are accredited at the time of sale)
- the issuer takes reasonable steps to verify the accredited investor status of each purchaser and
- the issuer complies with other applicable provisions of Regulation D.
See also the SEC’s Fact Sheet regarding the lifting of the ban on general solicitation and advertising.
General solicitation or general advertising could include soliciting investments through a website accessible to the general public, through a widely disseminated email or social media solicitation, through print media, such as a newspaper or magazine, or through other public statements. Issuers are not required to use general solicitation or general advertising and may continue to engage in private placements as they did under “old Rule 506” under new Rule 506(b). In connection with the new Rule 506(c) provisions, Form D is being revised to add a box that must be checked by those issuers who use general solicitation or general advertising in the offering.
Who is an accredited investor?
An accredited investor is generally perceived as a sophisticated person who is not in need of enhanced protection by the SEC. The new amendments did not change the definition of “accredited investor” in Rule 501(a). An “accredited investor” includes:
- an individual with a net worth greater than US$1 million (exclusive of the value of a primary residence), either individually or jointly with the individual’s spouse
- a natural person with income exceeding US$200,000 in each of the two most recent years or joint income with a spouse whose annual income exceeds US$300,000 for those years and a reasonable expectation of the same income level in the current year
- a trust with assets in excess of US$5 million, not formed to acquire the securities offered, whose purchases are directed by a “sophisticated person” as described in Rule 506(b)(2)(ii)
- a charitable organization, corporation or partnership with assets exceeding US$5 million
- a bank, insurance company, registered investment company, business development company or small business investment company
- an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of US$5 million
- a director, executive officer or general partner of the issuer or
- an entity in which all the equity owners are accredited investors.
Verification of accredited investor status
Previously, many issuers and funds utilized a check-the-box approach, whereby they relied solely on an investor’s representation that the investor is an “accredited investor” under one of the categories in Rule 501(a). Under the new rules, issuers utilizing general solicitation will also need to take “reasonable steps” to verify the accredited investor status of anyone to whom they sell securities under such offering. New Rule 506(c)(2)(ii) includes several non-exclusive methods that will be deemed to satisfy the verification requirement (provided that the issuer does not have knowledge that the purchaser is non-accredited), including:
- reviewing any US Internal Revenue Service (IRS) form that reports the purchaser’s income for the two most recent years 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
- reviewing, as to assets, bank, brokerage or other statements and, as to liabilities, a consumer report from at least one of the nationwide consumer reporting agencies dated within three months, and obtaining a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed or
- obtaining written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited investor status.
The SEC also included a form of “grandfather” provision in new Rule 506(c)(2)(ii)(D), which provides that for existing investors who were accredited investors in a Rule 506(b) offering prior to the effective date of Rule 506(c), a self-certification of accreditation status by such investor at the time of sale in a new offering by the same issuer under Rule 506(c) will be deemed to satisfy the verification requirement in Rule 506(c).
Some commenters have speculated that investors will be reluctant to provide such detailed personal information to issuers and fund managers, but may be willing to provide it to a neutral third party. Several registered broker-dealers have already started developing services to verify investors’ accredited status, such as SecondMarket’s Accreditation Verification Platform (AVP), and more will likely follow. Because brokers and CPAs have an investor’s financial information information already, certification from those sources may become commonplace.
Lifting the prohibition against general solicitation and general advertising may provide issuers with direct access to investors that is not currently available. However, issuers who choose to offer securities in this manner, and the persons associated with the issuer, will need to implement procedures for complying with accredited investor verification requirements, as well as updating such verification periodically if the offering is continuing or ongoing.