- Proposed Rule Amendments Would Permit General Solicitation and General Advertising in Certain Private Placements
- September 7, 2012 | Authors: Thomas M. Rose; Shona Smith
- Law Firms: Troutman Sanders LLP - Washington Office ; Troutman Sanders LLP - Atlanta Office
On August 29, 2012, the SEC published proposed amendments to Rule 506 of Regulation D (the safe harbor for the private offering exemption, often referred to as the accredited investor exemption) and Rule 144A (the resale exemption to qualified institutional buyers) under the Securities Act of 1933, as amended, to implement Section 201(a) of the JOBS Act which would remove the prohibition on general solicitation and general advertising. The SEC will seek public comment on the proposed amendments for a period of 30 days after the publication of the proposed rule in the Federal Register.
Proposed Amendments to the Accredited Investor Exemption under Rule 506
Rule 506 of Regulation D is an exemption from the registration requirements of the Securities Act which can be used by both public and private companies to offer and sell an unlimited amount of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. General solicitation and general advertisement of securities are currently prohibited in Rule 506 offerings. This prohibition on general solicitation and general advertising means that issuers need to have a pre-existing relationship with offerees in a Rule 506 offering, resulting in significant limitations on the ability of issuers to raise private capital in a Rule 506 offering.
The proposed amendments would add a new Rule 506(c) that would provide that the prohibition against general solicitation and general advertising contained in Regulation D would not apply to offers and sales of securities made pursuant to Rule 506, provided that:
the issuer takes reasonable steps to verify that all purchasers are accredited investors,
all purchasers of the securities are accredited investors, either because they fit within one of the categories provided in the definition of “accredited investor” or because the issuer reasonably believes that they do, at the time of the sale of the securities, and
all terms and conditions of Rule 501 (definitions) and Rules 502(a) (integration restriction) and 502(d) (resale limitations) of Regulation D are satisfied.
The proposed amendments would preserve under existing Rule 506(b) the ability of issuers to conduct Rule 506 offerings without the use of general solicitation and general advertising, for those issuers that either do not wish to engage in general solicitation and general advertising in their Rule 506 offerings (and therefore become subject to the new requirement to take reasonable steps to verify the accredited investor status of purchasers) or that wish to sell privately to non-accredited investors who meet Rule 506(b)’s sophistication requirements.
Verification of Accredited Investor Status
Under the proposed rule, whether the steps taken by an issuer to verify that all purchasers are accredited investors are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction. Under the stated purpose of providing flexibility, the proposed rule neither mandates a specific verification method nor lists a series of acceptable ones. Under the proposed approach, issuers would weigh a number of factors when determining the reasonableness of the steps taken to verify that a purchaser is an accredited investor. The proposing release provides the following examples of factors that an issuer might consider:
the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
the amount and type of information that the issuer has about the purchaser; and
the nature of the offering, such as the manner in which the purchaser is solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
Nature of the Purchaser
The definition of “accredited investor” includes natural persons and entities that come within certain categories, or that the issuer reasonably believes come within one of those categories, at the time of the sale of securities to that natural person or entity. Purchasers may be accredited investors based on their status (such as a registered broker or dealer), a combination of their status and the amount of their total assets (such as a corporation not formed to acquire the securities offered with total assets in excess of $5 million), and natural persons on the basis of either their net worth or their annual income.
The proposing release indicates that the steps that would be reasonable for an issuer to take to verify whether a purchaser is an accredited investor under the proposed rule would likely vary depending on the type of accredited investor that the purchaser claims to be. For example, the steps that may be reasonable to verify that an entity is an accredited investor by virtue of being a registered broker-dealer (such as by going to FINRA’s BrokerCheck website) would necessarily differ from the steps that would be reasonable to verify whether a natural person is an accredited investor. The proposing release acknowledges that taking reasonable steps to verify the accredited investor status of natural persons poses greater practical difficulties as compared to other categories of accredited investors and that these practical difficulties may be exacerbated by natural persons’ privacy concerns about the disclosure of personal financial information. The proposing release also acknowledges that it may be more difficult for an issuer to obtain information about a natural person’s assets and liabilities than information about a natural person’s annual income.
The question of what type of information would be sufficient to constitute reasonable steps to verify accredited investor status under the particular facts and circumstances of each purchaser would also depend on other factors described below.
Information about the Purchaser
The amount and type of information that an issuer has about a purchaser would be a significant factor in determining what additional steps would be reasonable to verify the purchaser’s accredited investor status. The more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it would have to take, and vice versa. If an issuer has actual knowledge that the purchaser is an accredited investor, then the issuer would not have to take any steps at all. Examples of the types of information that issuers could review or rely upon - any of which might, depending on the circumstances, in and of themselves constitute reasonable steps to verify a purchaser’s accredited investor status - include, without limitation:
Publicly available information in filings with a federal, state or local regulatory body. For example:
the purchaser is a named executive officer of an Exchange Act registrant, and the registrant’s proxy statement discloses the purchaser’s compensation for the last three completed fiscal years; or
the purchaser claims to be an Internal Revenue Code Section 501(c)(3) organization with $5 million in assets, and the organization’s Form 990 series return filed with the Internal Revenue Service (which such an organization is required to make public) discloses the organization’s total assets;
Third-party information that provides reasonably reliable evidence that a person falls within one of the enumerated categories in the accredited investor definition:
the purchaser is a natural person and provides copies of Forms W-2, personal bank and brokerage account statements, or similar documentation; or
the purchaser works in a field where industry or trade publications disclose average annual compensation for certain levels of employees or partners, and specific information about the average compensation earned at the purchaser’s workplace by persons at the level of the purchaser’s seniority is publicly available; or
Verification of a person’s status as an accredited investor by a third party, such as a broker-dealer, attorney or accountant, provided that the issuer has a reasonable basis to rely on such third-party verification.
Nature of the Offering
The nature of the offering, such as the means by which the issuer publicly solicits purchasers, may be relevant in determining the reasonableness of the steps taken to verify accredited investor status. An issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer. In the former type of offering, an issuer would not have taken reasonable steps to verify accredited investor status if it required only that a person check a box in a questionnaire or sign a form, without other information about the purchaser indicating accredited investor status. In the latter type of offering, an issuer would be entitled to rely on a third party that has verified a person’s status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification.
Terms of the Offering
The terms of the offering would also affect whether the verification methods used by the issuer are reasonable. A purchaser’s ability to meet a high minimum investment amount may be relevant to the issuer’s evaluation of the types of steps that would be reasonable to take in order to verify that purchaser’s status as an accredited investor. The ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors could reasonably be expected to meet it, with a direct cash investment that is not financed by the issuer or by any other third party, could be taken into consideration in verifying accredited investor status.
If after consideration of the facts and circumstances of the purchaser and of the transaction, it appears likely that a person qualifies as an accredited investor, the issuer would have to take fewer steps to verify accredited investor status, and vice versa. For example, if an issuer knows little about a potential purchaser claiming accredited investor status under one of the natural person categories, but the terms of the offering require a high minimum investment amount, then it may be reasonable for the issuer to take no steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by the issuer or by a third party (provided there are no facts that indicate that the purchaser is not an accredited investor).
Reasonable Belief Standard
The SEC confirmed that its proposed rulemaking will not eliminate the use of the “reasonable belief” standard found in Rule 501(a) (definition of “accredited investor”) when determining whether a purchaser is an accredited investor. The SEC’s affirmation of the ability of an issuer to rely on the reasonable belief standard is significant because it means that a 506 offering relying on the exemption in proposed Rule 506(c) will not be invalidated if, a purchaser is not, in fact, an accredited investor so long as the issuer took reasonable steps to verify that the purchaser’s accredited investor status. For example, if an issuer takes reasonable steps to verify a purchaser’s accredited investor status and has a reasonable belief that the purchaser is an accredited investor as a result of such reasonable steps, the issuer will not lose the ability to rely on the Rule 506 exemption as a result of the purchaser providing false information or documentation to the issuer as part of that verification.
Retention of Records Documenting Verification
It would be important for issuers to retain adequate records that document the particular steps taken to verify that a purchaser was an accredited investor, as an issuer claiming an exemption from the registration requirements of the Securities Act has the burden of showing that it is entitled to rely on that exemption.
Form D Amendments
The proposed rules would also revise Form D to add a separate check box for issuers to indicate whether they used general solicitation or general advertising in a Rule 506 offering.
Effect on Private Fund Exemptions under the Investment Company Act
Private funds generally rely on one of two exclusions from the definition of “investment company” under the Investment Company Act to exclude them from the regulatory provisions of that Act. Private funds are precluded from relying on either of these two exclusions if they make a public offering of their securities. The proposing release confirms that the amendments would permit private funds to use general solicitation or general advertising in a Rule 506(c) offering without losing either of the exclusions under the Investment Company Act.
Proposed Amendments to the Qualified Institutional Buyer Exemption under Rule 144A
The proposed amendment to Rule 144A would provide that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers, including by means of general solicitation and general advertising, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are qualified institutional buyers. Rule 144A currently provides a list of non-exclusive methods of establishing a prospective purchaser’s ownership and discretionary investments of securities for purposes of determining whether the prospective purchaser is a qualified institutional buyer.
Integration with Offshore Offerings
Regulation S provides a safe harbor for offers and sales of securities outside the United States and includes an issuer and a resale safe harbor. One of the requirements for both of these Regulation S safe harbors is that there be no directed selling efforts in the United States. Often, a U.S. or foreign issuer will conduct concurrent offerings in which the U.S. offering is conducted under Rule 506 or Rule 144A and the foreign offering is conducted under Regulation S. The SEC confirmed in its proposing release that a concurrent offshore offering conducted in compliance with Regulation S will not be integrated with a domestic offering using general solicitation or general advertising conducted in compliance with Rule 506 or Rule 144A, as proposed to be amended.