The Securities and Exchange Commission (SEC) took long-awaited action on July 10, 2013, to finalize and adopt new rules that eliminate the current prohibition against general solicitation and advertising in certain Rule 506 and in Rule 144A securities offerings and expand the bar on “bad actors” from participating in private securities offerings. In addition, the SEC issued proposed rules that would provide the SEC and the public with additional information where general solicitation and advertising are used in Rule 506 offerings.
Elimination of the Ban on Use of General Solicitation and Advertising
These final rules, first proposed in August 2012, implement the requirements of the Jumpstart Our Business Startups Act (JOBS Act) to eliminate the long-standing prohibition against use of general solicitation and advertising in private offerings. The final rules apply to offerings of securities that are sold only to accredited investors under Rule 506 of Regulation D or to qualified institutional investors (QIBs) under Rule 144A under the Securities Act of 1933.
The ability to use general solicitation and advertising under Rule 506 is predicated on the requirement that the issuer take reasonable steps to verify that purchasers of securities are accredited investors. General solicitation and advertising may be used in a Rule 144A offering, provided that securities are sold only to investors whom the seller reasonably believes to be QIBs. There is no limitation on whom the issuer can solicit in the offering. The final rules provide some non-exclusive methods that issuers can use to verify accredited investor status.
These final rules will become effective 60 days after publication in the Federal Register.
Disqualification of Bad Actors
The SEC also acted to implement the requirements of Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) to bar felons and other “bad actors” from participating in certain securities offerings. Under the final rule, an issuer may not rely on the Rule 506 exemption for a private offering if the issuer or any other “covered person” subject to the rule has experienced a “disqualifying event.”
The most noteworthy changes from the proposed rule, issued in May 2011, were:
The determination to consider only beneficial owners of 20 percent or more of the issuer’s voting securities as covered persons, not 10 percent holders as proposed
The addition of the Commodity Futures Trading Commission to the list of regulators whose regulatory bars and other final orders will trigger disqualification
The addition of SEC cease-and-desist orders for scienter-based anti-fraud violations and Section 5 violations to the types of final orders triggering disqualification
The addition of a definition of a “final order” that triggers disqualification
This final rule also will become effective 60 days after publication in the Federal Register.
Proposed Rule Covering Rule 506 Offerings Using General Solicitation and Advertising
As a companion to the Rule 506 amendments, the SEC also issued a proposed rule on July 10, 2013, intended to enhance its ability to monitor developments in the private placement market, as well as to address identified concerns about the use of general solicitation and advertising in Rule 506 offerings. The proposed rule, issued without the support of Commissioners Paredes and Gallagher, is subject to a 60-day public comment period.
Most notably, the proposed rule would require a pre-offering Form D filing at least 15 calendar days before engaging in general solicitation for the offering (as contrasted with the current post-sale filing requirement), add a disqualification period for future offerings for failure to comply with Form D filing requirements, enhance Form D disclosure requirements, provide legends and cautionary statements to be used in written general solicitation materials, and extend Rule 156 requirements currently applicable to registered investment companies to hedge funds and other private funds.
Impact of These Rules
The elimination of the ban on general solicitation paves the way for issuers, including hedge funds and other private equity funds, to reach a broad universe of potential new investors through the Internet, television, and newsprint. While issuers will be free to advertise broadly, they may sell only to accredited investors. To ensure they are selling to accredited investors, issuers should take certain steps now to document reasonable activities they expect to undertake to verify the accredited investor status of purchasers.
The proposed rule would add reporting and disclosure obligations. It also would expand Rule 156 prohibitions to the sales literature of private hedge funds and other private equity firms making general solicitations under Rule 506. We will continue to monitor the proposed rule. Finally, the bad actor disqualifications final rule expands such requirements as applicable to all Regulation D offerings.
For additional information on these rules, read our more detailed analysis.