Yesterday, the SEC adopted its final rules to eliminate the prohibition on general solicitation in Rule 506 Offerings as well as rules that prohibit certain “bad actors” from relying on Rule 506 exemptions. As detailed in my prior post, over 10 months ago the rules were proposed and that was only about two months after they were required to be adopted under the JOBS Act. I’m not sure that Captain Kirk would consider this warp speed….
Undoubtedly, there will be hundreds (maybe even thousands) of summaries of the rules written over the next couple of months. Having reviewed all 116 pages of the release adopting the rules as well as a related 185-page release regarding proposed rules to change the Form D filing requirements (more on that later) plus still managing a slalom waterski run (gotta love the length of the days in Minnesota this time of year), here’s my quick summary of what you really need to know about the final rules:
• The rules aren’t effective for another 60 days, so don’t run out and buy that remnant TV ad time from your local cable operator just yet.
• The rules don’t really impact existing 506 offerings (now Rule 506(b)), other than some of the proposed rules relating to Form D. If you want to do a 506 offering the “old fashioned” way (without general solicitation or advertising), you still can.
• Also, if you want to commence (or continue) a 506 offering, you can later use general solicitation in a “new” 506(c) offering without affecting your exempt status—as long as you comply with the new rules, once effective.
• The SEC adopted its general “facts and circumstances” approach to how issuers in Rule 506 offerings using general solicitation must take reasonable steps to verify accredited status.
• The general approach requires issues to consider certain factors (nature and available information about the investor, nature and terms of the offering, manner of solicitation, and investment amount). However, doing everyone a favor, the SEC added a non-exclusive list of four methods for verifying that a natural person is accredited that are deemed to meet the reasonable steps requirement:
o Issuers can review IRS filings to confirm annual income, along with a written representation from the investor regarding their expectation of reaching the necessary level of income in the current year.
o In verifying net worth of a potential investor, issuers can review certain listed types of documentation (bank and brokerage account statements, independent appraisal reports, certificates of deposit, and similar items) to determine the total assets and are required to review at least a credit report (from one of the nationwide reporting agencies) to determine liabilities, along with representations from the investor that all liabilities have been disclosed.
o Issuers can get written confirmation from any of the following types of individuals that they have taken reasonable steps to verify the accredited status of the investor within the prior three months:
- Registered broker-dealer
- SEC-registered investment advisor
- Licensed attorney
o Finally, if there are existing shareholders that invested in a prior Rule 506 offering as accredited investors, issuers can meet the verification requirement by having such individuals re-certify accredited status for the current offering.
• Because there will be a new box to check on the Form D (and it looks like the proposed regulation on Form D amendments will make the filing mandatory for 506 offerings with some penalties for non-compliance—see below), you’ll need to decide whether you are going to use a general solicitation and comply with the verification requirements to confirm that all investors are accredited or rely on the existing rules (without using any general solicitation).
• There are also final rules regarding the use of general solicitation by private funds, the adoption of the proposed amendments to Rule 144A for offerings to qualified institutional buyers, and how the new offerings related to offshore offerings and Regulation S (it’s a whole alphabet of fun for securities lawyers), but those are probably not as important to the entreVIEW reader as the rest of what’s detailed above.
The Good News—adding specific enumerated ways (albeit non-exclusive) to meet the verification requirement to the rules as originally proposed should at least provide some certainty for entrepreneurs raising capital.
The Bad News—as promised above, there is a whole set of new proposed amendments to the Form D filing requirements for Rule 506 offerings (some which would apply even to offerings that don’t use general solicitation). Just for fun, the SEC seems to be making life more difficult with these proposals for those raising capital right on the heels of adopting final rules which were supposed to make it easier. I’m not going to detail all of the proposed rules here (because most readers of this blog probably had only the attention span to get through about the first two paragraphs anyway), but the key points are:
• A Form D filing would be required before any general solicitation happens (rather than after the sale of securities as is the current requirement).
• Updated “closing” Form D’s would be required for all 506 offerings once they terminate.
• Requiring certain legends and other disclosures in offerings that use general solicitation (not a huge deal, because much of this is typically covered already in offering materials).
• Require (at least for the next two years) that written general solicitation materials be filed with the SEC.
Perhaps of most importance in the proposed rules, the disqualification of an issuer from using Rule 506 for future offerings if it has failed to make required Form D filings within the last five years. I guess the cavalier practice of some securities lawyers (you know who you are) to advise clients there isn’t any reason to make the filing could become a thing of the past, although the proposed rules have already drawn some critcism from a couple of commissioners who think it undermines Title II of the JOBS Act. I can't say I disagree.
Stay tuned to see what happens with these proposed rules (and the Crowdfunding rules, which haven’t even been proposed yet). Congress giveth and the Regulators taketh away…