• Liberalizing SEC Rule 506: Not So Fast!
  • November 20, 2012 | Author: Gregory S. Fryer
  • Law Firm: Verrill Dana LLP - Portland Office
  • On August 29, 2012 the Securities and Exchange Commission published a rule proposal to allow advertising in so-called “accredited only” offerings under SEC Rule 506. At the time, there was reason to hope that a final rule might be in place by late October. That didn’t happen, and it is now unclear whether the Commission will be substantially revamping its proposal.
     
    *   *   *

    The August 29 rule proposal was made in response to a statutory mandate under the Jumpstart Our Business Startups Act. Section 201 of the JOBS Act requires that the Commission revise Rule 506 to remove the prohibition against “general solicitation” and “general advertising” for offers and sales of securities to wealthier investors. Specifically, that prohibition will not apply to offerings made pursuant to the Rule if all purchasers of the securities fit the definition of “accredited investors,” and the issuer takes reasonable steps to verify their status as such.

    The JOBS Act actually called for final adoption of a new rule no later than 90 days after the statute’s enactment - i.e. by July 4 - and the SEC received more than a little flak for not even publishing a proposed rule by that date. To its credit, the Commission had warned that this timetable was impracticable, and it did publish its proposal within eight weeks after the deadline. In so doing, the Commission set a 60 day deadline for comments (i.e. by October 5).

    The SEC’s proposed Rule 506 changes and the accompanying Proposing Release on August 29 were relatively straightforward. The Commission’s proposed approach would neatly sidestep numerous complexities which commenters had raised but which seemed to overthink the core statutory mandate and expedited timetable.

    Between August 29 and October 5, the Commission received nearly 150 comment letters. And after October 5, the comments kept coming.

    One in particular caught peoples’ eye. On October 12, seven U.S. Senators submitted a letter insisting that the SEC fundamentally restructure its rule proposal. The letter asserted that "Congress did not contemplate removing the general solicitation ban -- without retaining any limitations on forms of solicitation -- for private investment vehicles." These seven Senators faulted the Commission for not recognizing the need under Section 201 of the JOBS Act to distinguish between "issuers that engage in operational businesses" and "those that are merely investment vehicles." The language of Section 201 seems to flatly contradict the Senators’ reading of Congressional intent, and the legislative record seems devoid of evidence that Congress wanted the SEC to draw narrow distinctions between different types of issuers that seek capital. Even so, a letter like this had sufficient heft to assure a temporary freeze on regulatory activity - in this case, at least through Election Day.

    So where are we now?

    On November 15, the SEC held its annual Government-Business Forum on Small Business Capital Formation. Rule 506 was very much on the agenda, and the SEC Staff was asked to comment on the status of its August 29 proposal. The Director of the Division of Corporation Finance replied: “It’s challenging. We have received a lot of comments, and are trying to balance the competing interests. We are working as hard as we can to come up with recommendations to the Commission.” To my ear, it doesn’t sound as though a final rule is imminent, and it doesn’t sound as though the Staff is merely working on a few tweaks to the August 29 proposal.

    This all started as a 90-day mandate to remove advertising restrictions for offerings limited to accredited investors. It is possible that the Commission will simply endorse its prior proposal, with few changes. However, considering the amount of time that has passed and the barrage of commentary, it is quite possible that we could be in for a more fundamental re-write of the proposal and a further comment period.

    As previously noted, the lifting of advertising strictures has many interesting potential implications such as: freeing up companies to seek favorable media attention; allowing the issuer to use its public website to pursue attention from investors; giving local and regional broker-dealers new incentives to get back into the “retail” private placement market; opening up new sources of debt financing for nonpublic companies with established reputations; and (unless the seven Senators prevail) making it more economical for private investment funds to raise new capital. Clients may wish to start planning for these possibilities, even though the exact timing of the coming liberalization remains uncertain.