The following is a guest post prepared by Lee Liebolt. Mr. Liebolt may be contacted at firstname.lastname@example.org.
The Securities and Exchange Commission took some long-awaited action in the area of private offerings at its open meeting on July 10, 2013. The Commission issued two releases adopting final rules (i) to eliminate the prohibition against general solicitation and general advertising in offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933, provided, among other things, that all of the purchasers of the securities are “accredited investors” and (ii) to disqualify felons and other “bad actors” from such offerings. The rules become effective on September 23, 2013. These measures were undertaken to comply with mandates in both the Jumpstart Our Business Startups Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act. At the same time, the Comission issued a release proposing rules to amend Regulation D and Form D to enhance the Commission’s ability to study market practices and address concerns that may arise as a result of these rule amendments. How, you might ask, do these actions at the federal level affect Rule 506 offerings under the “blue sky” or state securities laws?
Eliminating the Prohibition Against General Solicitation. In 1996, Congress passed the National Securities Markets Improvement Act. It amended Securities Act § 18 to provide that a security sold in an offering in compliance with Rule 506 would be deemed to be a “covered security” and hence preempted from blue sky regulation so long as a simple notice filing was made to perfect the exemption under state law. The Commission’s action to lift the ban on general solicitation and general advertising will have no effect on the blue skying of such covered security offerings. What is now a Rule 506(b) offering will be as it always was. An offering under new Rule 506(c) will still result in a covered security and enjoy the same federal preemption, albeit with the NSMIA notice filing.
However, where lifting the ban in 506 offerings will make a difference will be in those instances where issuers have in the past relied upon a limited offering exemption rather than making the NSMIA notice filing. For example, the Uniform Securities Act (2002), which has been adopted in 18 states but not necessarily uniformly, provides for a self-executing exemption for an offering to not more than 25 purchasers in the state (other than any institutional investors) so long as certain conditions are met, among which is that, “a general solicitation or general advertising is not made in connection with the offer to sell or sale of the securities.” This exemption will no longer be available after the Comission’s rule amendments take effect. Similarly, while the traditional limited offering exemption in the 1956 Uniform Securities Act does not explicitly contain a ban on general solicitation, it is entirely likely that by rule or policy a given state enforces such a ban on any claim for exemption under that provision. Thus, in this case also, a blue sky exemption will not be available for an offering under Rule 506(c).
Of course, the above comments do not apply to the universal exemption for transactions with institutional investors nor to the more limited number of exemptions for sales to individual accredited investors.
Rule 144A. In its release, the Commission also tweaked Rule 144A under the Securities Act with the practical effect of opening up such offerings to general solicitation as well. That should not make any difference blue sky-wise. Since those offerings are sold only to “qualified institutional buyers,” there will always be a blue sky exemption available for transactions with institutional investors.
Disqualification of Felons and Other Bad Actors. The Commission’s decision to bring these disqualifications to 506 offerings is a throwback to the pre-NSMIA days when “bad boy” certificates had to be obtained for blue skying offerings in many of the states. Since the disqualifications now become a federal requirement, the Commission’s action will not have a direct impact upon blue sky, except as discussed below.
Occasionally, “finders” or other such persons receiving payment for bringing investors to an offering (referred to as “compensated solicitors” by the Commission in its release) are unlicensed individuals. Already they are picked up by Items 12 and 15 in the Form D as it was revised by the Commission in 2008 for electronic filing. Their participation in the offering and lack of registration can be a red flag for any state regulator scrutinizing an offering. Now issuers will have to be alert to whether they need to disclose if such persons have engaged in any disqualifying events prior to the effectiveness of new paragraph (d) to Rule 506, and for the possible exclusion of such persons from any offering conducted afterwards.
Proposed Amendments to Regulation D and Form D. A couple of the proposals may, if adopted, be problematic for blue sky practice.
For example, the proposed rules would add on a temporary basis for two years new Rule 510T of Regulation D to facilitate the Commission’s ability to monitor offerings made where general solicitation is used. The rule would require an issuer conducting an offering in reliance on Rule 506(c) to submit to the Commission“any written general solicitation materials” used in connection with the offering. Although the solicitation materials would not be treated as being “filed” with the Commission, query whether that benign treatment could change through the comment-making process to the point where the states could require that they be filed with them, as a “document filed with the Commission” under Securities Act § 18? Alternatively, will the Commission’s request for comment on whether such materials should be required to be submitted as an exhibit to Form D, as some states have urged, end up being a backdoor to review by the blue sky authorities?
The Commission proposes in its release that an “Advance Form D” be filed 15 calendar days before the first use of general solicitation in a 506(c) offering and that a closing Form D amendment be filed within 30 calendar days after the termination of any 506 offering. Since the release references that the state securities regulators were active commenters on these points in the earlier proposing release, one can assume that they will be deeply interested in having these proposals adopted. Until such time as the North American Securities Administrators Association establishes a one-stop filing system for Regulation D offerings, having to make these additional Form D filings at the state level will be an extra burden on issuers.