- SEC Adopts Rules to Allow General Solicitation in “Accredited-Only” Private Placements
- July 22, 2013 | Authors: Gregory S. Fryer; Gabriel B. Weiss
- Law Firm: Verrill Dana LLP - Portland Office
(July 17, 2013) In a much-awaited action, the Securities Exchange Commission has voted to adopt final rules that will allow issuers of securities to use advertising and other forms of general solicitation in “accredited-only” private placements under SEC Rule 506. Through this vote, the Commission has adopted a controversial set of rules that it proposed nearly one year ago. In so doing, the Commission also simultaneously adopted or proposed other important rules that will affect these types of offerings.
These new changes to Rule 506 could dramatically alter a company’s ability to seek capital from private investors. Set forth below is a brief summary of this complex set of requirements and proposals.
In April 2012, the President signed into law the Jumpstart Our Business Startups (JOBS) Act. That statute contained numerous provisions to reduce the expense and complexity of securities offerings. Section 201(a)(1) of the JOBS Act required the SEC to amend Rule 5061 to allow general solicitations if the issuer takes reasonable steps to verify that the offered securities are sold only to so-called accredited investors.
On August 29, 2012 the SEC published a proposed set of amendments to Rule 506. See our earlier summary of these proposed amendments: “Liberalizing SEC Rule 506 to Allow Advertising in "Accredited-Only" Offerings: One Step Closer” www.verrilldana.com/secrule506. The proposed rule sparked an avalanche of public commentary, with many supporting increased freedom to advertise as a means of encouraging capital formation, and many others voicing concern over potential abuse by issuers and perceived decreases in investor protections.
On July 10, 2013, the SEC voted to adopt, in final form, the same rule amendments proposed last August, but with one significant set of changes.2 On that same day, the SEC published final rules on “bad actor” disqualifications from the use of Rule 506 generally, and also published an extensive set of proposed changes regarding disclosures and filings for certain Rule 506 offerings.
New Rule 506(c)
In its recent action, the SEC adopted a new exemption - denominated as Rule 506(c) - which lifts the prior ban on general solicitation of potential investors if the issuer has taken reasonable steps to verify that each and every purchaser of the offered securities is an accredited investor. 3 This important amendment to Rule 506 becomes effective 60 days after publication in the Federal Register - i.e. in mid-September.
Safe-Harbor Methods of Verifying Accredited Status
One controversial aspect of the August 29 rule proposal was that the SEC did not include “safe harbor” procedures by which an issuer would be deemed to have met the JOBS Act’s verification requirements. The new Rule 506(c) in its final form, however, does include four different safe-harbor methods for verifying accredited investor status, as follows:
1. For a natural person, income may be verified by examining copies of IRS tax filings that report the person’s income (e.g., Form W-2 or 1099 or a copy of relevant pages from the investor’s 1040 income tax return) for the past two years, and by obtaining a written representation from the investor that he or she reasonably expects to receive a qualifying amount of income for the current year.
2. For a natural person, net worth may be verified by reviewing:
a. For assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties; and
b. For liabilities: a consumer/credit report from at least one of the nationwide consumer reporting agencies
and obtaining a written representation from the investor that he or she has disclosed all relevant liabilities necessary to make the net worth determination.
3. For any type of investor, by obtaining written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney or certified public accountant that such third party “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.4
4. For a natural person who was considered to be an accredited investor as to securities previously purchased from an issuer before new Rule 506(c) went into effect, that person will be deemed an accredited investor in a new offering by the same issuer if the person certifies in writing that he or she currently qualifies as an accredited investor.
These four safe harbors are not intended to be the only acceptable methods for meeting the JOBS Act’s verification requirements. As the SEC pointed out in its prior August 29 release and its recent July 10 release, Rule 506 offerings are made under a wide range of circumstances, and there are many possible ways in which an issuer might reasonably verify an investor’s status. In the case of sales to an investor who is already well known to the issuer’s management, pre-existing knowledge might constitute sufficient verification of status. The lengthy and nuanced discussions in both the August 29 and July 10 releases, however, make it clear that mere self-certification (e.g., by the investor checking a box in a subscription agreement which states that he or she is accredited) generally will often not suffice except in the case of “grandfathered” investors described in method #4 above. Instead, self-certification generally will need to be accompanied by other facts that tend to confirm the certification as being accurate and reliable.
Effect on Old Rule 506
In adopting new Rule 506(c), the SEC decided not to make any immediate changes to Rule 506 conditions where the issuer does not intend to utilize general solicitation. In other words, the old Rule 506 is still available under its prior terms (including the absence of general solicitation), but now is designated as Rule 506(b).
Proposed Future Changes to Form D; Other Proposed Disclosures
Rule 503 under Regulation D has long required the issuer to file with the SEC an informational notice on Form D, and most states require a Form D filing as a condition to claiming analogous state registration exemptions. The August 29 rule proposal had included only one change to the Form D notice itself - to add a new checkbox on the front page showing whether the issuer is relying on the new Rule 506(c) or is relying on “old” Rule 506(b). That change was adopted in the June 10 release. Therefore, issuers that wish to use advertising or other forms of general solicitation (and thus are willing to restrict the offering solely to accredited investors) will need mark the front page of Form D accordingly.
At the same time, however, the SEC has published a proposed set of rules that would make extensive changes to Form D. Here are some highlights of the proposed changes:
Current Rule 503 allows the Form D to be filed 15 days after the first sale of securities. In the case of Rule 506(c) offerings, the SEC is proposing to require an initial filing at least 15 days before the first use of any general solicitation.
Form D would require Rule 506(c) issuers to provide additional information, such as the types of general solicitation they intend to use and how they plan to verify accredited investor status.
Current Rule 503 generally does not require a Form D to be filed upon completion of the offering. In the case of Rule 506(c) offerings, the SEC is proposing to require a closing Form D amendment to be filed within 30 days after termination of the offering.
To further encourage filings, the SEC is proposing that if an issuer (or any affiliated company) fails to timely file Form D for a Rule 506 offering, then for at least one year thereafter it will be disqualified from relying on Rule 506 for any other offering. The disqualification would run for 12 months from the date a curative filing is made, and can be waived by the SEC in particular cases.
Historically, Rule 506 did not impose any disclosure content requirements if the offering was being made solely to accredited investors. To address investor protection concerns, however, the SEC has now proposed two sets of content requirements for Rule 506(c) offerings:
New Rule 509 under Regulation D would require inclusion of certain legends on all offering materials and — at least for a temporary two-year period — would require each issuer to file a copy of all general solicitation materials with the SEC on a confidential basis.
In the case of hedge funds, venture capital funds and other pooled investment vehicles, Rule 156 would be expanded to impose disclosure requirements on “private funds” that are not registered under the Investment Company Act. Currently Rule 156 imposes disclosure requirements only on registered investment companies.
The proposed amendments to Form D, Rule 509 and Rule 156 are subject to a 60-day public comment period. Judging by the volume of comments on the August 29 proposal, we can expect a very large number of comments on this latest set of proposed rules. It remains to be seen whether those comments will result in further changes or delays in the proposed rules.
New Disqualifications for Bad Actors
Concurrently with the July 10 release setting forth new Rule 506(c), the SEC issued a companion release5 that amends Rule 506 to disqualify an issuer from relying on Rule 506(b) or Rule 506(c) if the issuer or any of its associated persons fall within various “bad actor” categories. Similar disqualifications were already in effect for another Regulation D exemption (Rule 505) and for the Regulation A exemption. Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (enacted in 2010) required the SEC to impose felon and other bad actor disqualifications on Rule 506 offerings as well.
The new disqualifications are found in new Rule 506(d) and are considerably broader than those currently in effect for Rule 505 and Regulation A offerings. Rule 506(d) will take effect in mid-September (60 days after publication in the Federal Register). Rule 506 issuers are required to investigate whether any such bad actor events occurred before that effective date, and under new Rule 506(e) are required to disclose such events in writing to prospective investors a reasonable time prior to sale of the offered securities.
Until now, the “private placement” exemption was unavailable if the issuer used general advertising or other forms of general solicitation to help market its securities. Rule 506(c) fundamentally alters the concept of what it means for an offering to be “private,” so long as the issuer takes reasonable steps to verify that each and every purchaser of the securities meets the standards for accredited investors.
The lifting of constraints against advertising 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 making it more economical for private investment funds to raise new capital. Rule 506(c) does not take effect until mid-September, and companies should be careful not to engage in general solicitations for capital before that date. In the interim, however, companies now have certainty about the timing of this important new liberalization in U.S. securities laws.
1Rule 506 is a private placement exemption from securities registration requirements under the Securities Act of 1933. First promulgated by the SEC in 1982, Rule 506 is found within a set of rules known as Regulation D. In 1996 Congress passed legislation by which issuers that meet the requirements of Rule 506 are also entitled to exemptions from securities registration requirements under all applicable state securities laws. The SEC estimates that nearly $900 billion of capital was raised in 2012 through Rule 506 offerings (i.e. nearly three-quarters as much as was raised in registered public offerings in the United States during that same year).
2The SEC’s July 10 release can be found at http://www.sec.gov/rules/final/2013/33-9415.pdf. The earlier August 29 release can be found at http://www.sec.gov/rules/proposed/2012/33-9354.pdf.
3The term “accredited investor” is defined in Rule 501 of Regulation D. The definition is complex and includes a number of qualifying categories. In the case of individuals, a purchaser will qualify if he or she currently has a net worth of at least $1 million (excluding primary residence) or has an annual income of more than $200,000 (or $300,000 joint with a spouse) for the past two years and a reasonable expectation of meeting that income threshold in the current year. In the case of entities, a purchaser will qualify if it has at least $5 million in total assets or is owned solely by persons who themselves qualify as accredited investors. A person whom the issuer reasonably believes to be an accredited investor is deemed to satisfy the definition, but new Rule 506(c) will likely have the effect of increasing the level of investigation needed to reach a “reasonable” conclusion in this respect.
4Outside of this particular safe harbor, issuers should be able to rely on verifications from other third parties (beyond those listed) if doing so would constitute reasonable assurance of accredited investor status.
5See http://www.sec.gov/rules/final/2013/33-9414.pdf. The initial rule proposal was published May 25, 2011 and can be found at http://www.sec.gov/rules/proposed/2011/33-9211.pdf.