• SEC Lifts Ban on General Solicitations for Certain Private Placements
  • July 18, 2013 | Authors: Matthew D. Armstrong; Rebecca H. Forest; Peter E. Reinert
  • Law Firm: Lowndes, Drosdick, Doster, Kantor & Reed Professional Association - Orlando Office
  • On July 10, 2013, the SEC adopted a rule lifting the ban on “general solicitations” for certain private offerings. Specifically, funds and other issuers offering securities to prospective investors pursuant to new Rule 506(c) under Regulation D (“Rule 506”) of the Securities Act of 1933 (the “33 Act”) will now be able to “generally solicit” to prospective investors if all investors admitted to the funds are “accredited”[1] at the time of purchase and the issuer has taken reasonable steps to verify such accredited status. The new rule will be added as a new subsection (c) to existing Rule 506 and the existing exemption contained in Rule 506 will remain available for issuers as Rule 506(b). Funds interested in making, or intending to make, general solicitations under the new Rule 506(c) should contact legal counsel in order to (i) confirm the effective date of the new exemption, (ii) understand the new requirement for verification of accredited status, which must be satisfied even if all investors are, in fact, accredited, and (ii) understand the scope of permissible “general solicitation.”

    The concept of “general solicitation” for private securities offerings is not expressly defined in securities laws, but is commonly understood to mean forms of advertisement through methods such as television and radio broadcasting, print media, and face-to-face solicitation at presentations, meetings, and/or seminars where invitations are extended by general, unrestricted advertisements. Use of unrestricted websites also has been deemed to constitute general solicitation. Under the new rule, all forms of communication to prospective investors are now permitted, even those which have historically been considered to be prohibited “general solicitation” or “general advertising.” However, funds and other issuers may only admit investors under new Rule 506(c) offerings who are “accredited” within the meaning of the 33 Act, and must take reasonable steps to verify such “accredited” status for all admitted investors.

    Historically, the process for adequately verifying “accredited” status for prospective investors was ambiguously defined and subject to a general “facts and circumstances” standard. Notably, the new rule provides guidance on proper verification of “accredited” status by providing a non-exclusive list of verification methods which are deemed to be sufficient by the SEC, providing issuers greater certainty in satisfying the verification requirement and the flexibility to develop tailored verification standards. The new rule will require verification methods that are over-and-above the traditional “check-the-box” investor questionnaire typically required by issuers, and will create an opportunity for third-parties and broker-dealers to provide outsourced investor verification services to funds. Verification of “accredited” status by means other than the methods identified in the new Rule 506(c) will still be possible, but will be subject to the existing “facts and circumstances” standard.

    The new rule does not eliminate the current exemption contained in Rule 506, which will serve as an alternative to the new Rule 506(c) under Rule 506(b) and will continue to prohibit “general solicitation.” Rule 506(b) offerings may still include up to 35 non-accredited investors under the conditions set forth in the rule. As the exemptions set forth in Regulation D, including Rule 506, are safe harbors, issuers also may continue to rely on the exemption from registration set forth in Section 4(a)(2) of the Securities Act, which will continue to prohibit general solicitation and advertising.

    With respect to offerings that commenced prior to effective date of new Rule 506(c), the issuers may choose to continue such offerings after the effective date in compliance with either Rule 506(b) or Rule 506(c). Any general solicitation occurring after the effective date for offerings continued under Rule 506(c) will not affect the exempt status of offers and sales that occurred prior to the effective date under Rule 506(b).

    New Rule 506(c) is intended to benefit issuers by enabling them to solicit investors directly through mailings and newspaper advertisements, social media, email, radio and television, providing greater access to sources of capital at lower cost by reducing the need to use intermediaries in the capital raising process. The new rule also is intended to provide investors with additional investment opportunities. New Rule 506(c) was adopted pursuant to the Jumpstart Our Business Startups Act (the “JOBS Act”) adopted in 2012. It will not be deemed effective until 60 days after its publication in the federal register, which has not yet occurred.

    In order to provide investors protection against possible fraud and other abuses resulting from the removal of the ban on general solicitation, the SEC also approved an amendment to disqualify offerings under Rule 506 which involve certain felons and “bad actors.” Existing prohibitions against misleading and/or fraudulent communications, as well as other general requirements for private placements, will remain effective. The SEC also presented a proposed rule for public comment that is aimed to limit abuse of Rule 506 and provide the SEC with additional methods to monitor such abuse. The new Rule 506(c) will also preempt many state “Blue Sky” laws prohibiting “general solicitation,” but states might take new actions to control “general solicitation” with new laws under the existing parameters of Federal preemption. Funds and other issuers seeking to make “general solicitations” should consult with legal counsel to understand the effect of new state laws.

    Also on July 10, 2013, Rule 144A under the 33 Act also was amended to pursuant to the JOBS Act to provide that securities sold under the rule may be offered to persons other than qualified institutional buyers (“QIBs”), including by use of general solicitation, provided that only the securities are sold only to QIBs or purchasers that the seller (and anyone acting on the seller’s behalf) reasonably believes are QIBs. QIBs generally are large institutional buyers and include entities such as mutual funds, pension funds, banks, savings and loan associations, investment companies, insurance companies and other entities owned entirely by QIBs. Rule 144A is a non-exclusive safe harbor that permits resales of certain restricted securities without registration. Issuers often use Rule 144A in capital raising efforts by making a primary offering of securities to one or more financial intermediaries that is exempt under 4(a)(2) or the 33 Act who then resell the securities to QIBs under Rule 144A. Since only QIBs are permitted purchasers under Rule 144A and are well-known, sophisticated investors, the benefit of the modification to the rule to permit offers to non QIBs is not likely to have as much of an impact on issuers’ ability to access QIBs but should make information about 144A securities more widely available in the Rule 144A securities market. The Rule 144A amendment will become effective concurrently with the amendment to Rule 506.

    Please refer to our article entitled JOBS Act Serves to Assist Companies with Raising Capital and Jumpstarting the Job Market dated May 10, 2012.

    [1] An investor is deemed “accredited” if: (a) his/her annual income is greater than $200,000 per year (or $300,000 per year jointly with spouse) in each of the past two years, with a reasonable expectation of the same income level during the current year; or (ii) he/she has a net worth (individually or jointly with spouse) greater than $1,000,000 (disregarding the net value of the investor’s primary residence).