The SEC recently proposed rules mandated by the Jumpstart Our Business Startups Act (the “JOBS Act”) to eliminate, in certain securities offerings pursuant to Regulation D under the Securities Act, the prohibition against general solicitation and general advertising and restrictions against offering securities to investors that are not Qualified Institutional Buyers (“QIBs”) under Rule 144A under the Securities Act.[1] As envisioned by the JOBS Act, these rules are intended to make it easier for issuers to raise capital by facilitating their ability to communicate to potential investors during capital raises.
As contemplated by Section 201(a) of the JOBS Act, the proposed rules would amend (i) Rule 506 of Regulation D to permit general solicitation and general advertising in securities offerings sold only to accredited investors, while requiring the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors and (ii) Rule 144A(d)(1) to permit offers for resales of securities (as opposed to actual resales) to investors that are not QIBs. The rules attempt to balance Congress’s directive that issuers be given the ability to communicate freely to attract capital, while mitigating the risk of securities being sold to unqualified participants. The SEC, in proposing these rules, declined to impose additional restrictive measures suggested by commentators, such as tightening the definition of accredited investor. The SEC is soliciting comments on numerous questions raised in the release; the comment period on the proposed amendments expires on October 5, 2012.
Regulation D And Proposed Rule 506(c)
Rule 506 of Regulation D provides a safe harbor from registration under the Securities Act for private placements under Section 4(a)(2) of the Securities Act. Under Rule 506, offers and sales of an unlimited dollar amount of securities are permitted, without registration under the Securities Act, to an unlimited number of accredited investors (and up to 35 non-accredited investors), as long as there is no general solicitation and no general advertising, appropriate resale limitations are imposed and certain other conditions are met. In addition, because securities sold under Rule 506 are “covered securities” under Section 18(b)(4)(E) of the Securities Act, substantive state securities law requirements that would otherwise be applicable are preempted.
Proposed Rule 506(c) would permit offerings under conditions generally consistent with offerings under current Rule 506(b), with three notable exceptions: (i) general solicitation and general advertising would be permitted; (ii) all investors would need to be accredited investors or persons the issuer reasonably believes to be accredited investors at the time of the sale of the securities; and (iii) the issuer would be required to take reasonable steps to verify that purchasers of the securities are accredited investors.[2] The proposed rules reaffirm previous guidance by the SEC on what constitutes general solicitation or general advertising but do not provide additional clarity.
The release also seeks to clarify the methods of verifying accredited investor status that would satisfy Rule 506(c). These methods are intended to reduce the risk that the use of general solicitation under Rule 506(c) could result in sales of securities to non-accredited investors while providing issuers with sufficient flexibility to permit the varying types of offerings and accredited investors that may fall under amended Rule 506. The SEC suggests that reasonable steps to verify accredited investor status would involve consideration of a number of interconnected factors, including:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be (with the status of natural persons being more difficult to verify);
- the amount and type of information that the issuer has about the purchaser (with more information requiring fewer steps for verification, and vice versa); and
- the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering (for example, via public website vs. database of pre-screened accredited investors maintained by a reliable third party), and the terms of the offering, such as a large minimum investment amount.[3]
While the SEC does provide guidelines as to what it expects will constitute reasonable steps to verify accredited investor status, the proposed rules are short on specific methodologies or processes, and whether particular steps are sufficient remains a “facts and circumstances” analysis. According to the SEC, a list of specified methods for satisfying this requirement “would be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor” and could potentially create requirements that are overly burdensome. Regardless of the specific method of verification employed by an issuer, it is important to remember that any issuer claiming an exemption from the registration requirements of Section 5 of the Securities Act bears the burden of proving that such exemption was properly relied upon.
Form D
The SEC has also proposed amending Form D, which issuers file with the SEC when they sell securities in reliance on the Regulation D exemption. The revised form would add a separate box for issuers to check if they are claiming the new Rule 506(c) exemption permitting general solicitation and general advertising, helping the SEC gather data on the use of general solicitation and general advertising in offerings relying on Rule 506(c).
Rule 144A
Rule 144A of the Securities Act provides a safe harbor from securities registration under the Securities Act for certain private resales of securities to QIBs. This exemption is typically employed in the context of a capital raise by an issuer that initially sells securities to financial intermediaries, referred to as “initial purchasers,” in a private placement under Section 4(a)(2) of the Securities Act, with such initial purchasers immediately reselling such securities to QIBs under Rule 144A.
The proposed rules would amend Rule 144A(d)(1) to provide that securities to be sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation and general advertising, provided that the securities are actually sold only to QIBs or persons that the seller reasonably believes to be QIBs. The release does not discuss what would constitute “reasonable belief” of QIB status and seeks comments as to whether the existing list of non-exclusive methods for establishing a prospective purchaser’s QIB status under the current Rule 144A has worked in practice.
Privately Offered Funds
Privately offered funds generally rely on certain exclusions from the definition of “investment company” under the Investment Company Act; however, these exclusions are not available if the funds make a public offering of their securities. The release confirms that the SEC’s historic treatment of Rule 506 transactions as non-public offerings will continue to permit privately offered funds to make a general solicitation under new Rule 506(c) without losing these exclusions under the Investment Company Act.
Regulation S Offerings And Integration Concerns
The release confirms that concurrent offshore offerings conducted in compliance with Regulation S would not be integrated with domestic unregistered offerings conducted in compliance with Rule 506 or Rule 144A, as proposed to be amended. However, the SEC does not address the integration of Rule 506(c) offerings involving a general solicitation with other private placements not involving any general solicitation. To avoid any concerns, an issuer may need to wait the six-month safe harbor period specified in Rule 506(a) following completion of an offering under Rule 506(c) involving general solicitation before commencing an offering to unaccredited investors under Rule 506(b).[4]
With the issuance of this release, the SEC has taken a step toward meeting the Congressional directives set forth in the JOBS Act and expanding issuers’ abilities to communicate with potential investors in certain unregistered offerings of securities. The release has attempted to balance the competing concerns of the facilitation of capital raises and investor protection and is already attracting criticism from both sides that it went too far in the other direction. The release is certain to draw continued interest, with both the markets and regulators paying close attention to its likely consequences.
[1] See SEC Release No. 33-9354 (August 29, 2012), available at http://www.sec.gov/rules/proposed/2012/33-9354.pdf.
[2] Current Rule 506(b) would remain available to permit the offer and sale of securities to a limited number of unaccredited investors without the use of general solicitation.
[3] The release specifically notes that an issuer that solicits new investors through a public website would not have taken sufficiently reasonable steps to verify accredited investor status if such issuer only required a person to check a box in a questionnaire or sign a form (absent other information indicating accredited investor status).
[4] Similarly, many private fund issuers currently making offerings in reliance on Rule 506 of Regulation D may wish to begin generally soliciting investors or advertising their funds following approval of new Rule 506(c). We hope that the SEC’s adopting release clarifies that there is no need to stop offering under Rule 506 and wait the six-month safe harbor period before proceeding to generally solicit under Rule 506(c).
Published September 21, 2012.