The SEC recently finalized amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act relaxing prohibitions against general solicitation in certain private offerings of securities implementing Section 201(a) of the Jumpstart Our Business Startups Act (“JOBS Act”), while adopting bad actor disqualification provisions for all private placements under Rule 506 implementing Section 926 of the Dodd-Frank Act.  Both of these rule amendments will be effective on September 23, 2013.

Aside from the significant impact of these changes on issuers, the SEC’s releases also expressly identified broker-dealers and investment advisers as market participants likely to be affected by these rules.  Registered broker-dealers often act as intermediaries that facilitate Rule 506 offerings, while investment advisers organize and sponsor pooled investment funds that conduct Rule 506 offerings in an issuer capacity.

As discussed in greater detail in the publications referenced below, broker-dealers and investment advisers will be affected directly or indirectly by these rules in several ways:

• SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers, and investment companies and their associated persons will constitute disqualifying events under the “bad actor” rule.
• The scope of the bad actor rule will be expanded by using the term “investment manager” rather than “investment adviser.”  This is meant to ensure that control persons of pooled funds that deal in instruments other than securities, such as commodities, real estate and certain derivatives, are covered persons and subject to disqualification under the bad actor rule.  This revision recognized that, unlike operating companies making Rule 506 offerings, most pooled investment funds engaging in Rule 506 offerings function through their investment managers and their personnel and have few, if any, employees.
• An issuer may rely on Rule 506’s exemption even if there is a disqualification as to a covered person, such as a broker-dealer, if the issuer can demonstrate that it did not know and, in the exercise of reasonable care, it could not have known about the disqualification at the time of the sale of securities.  Although issuers are generally required to exercise that reasonable care and conduct associated factual inquiries themselves, when a registered broker-dealer acts as placement agent, it may be sufficient for the issuer to make inquiries concerning the relevant set of covered officers and controlling persons, and to consult publicly available databases concerning the past disciplinary history of the relevant persons.  Broker-dealers are already required to obtain much of this information for their own compliance purposes, and the SEC anticipates that financial intermediaries and other market participants will develop procedures for assisting issuers in gathering the information necessary to satisfy the issuer’s factual inquiry requirement.
• Existing FINRA rules governing offering-related communications, such as FINRA Rule 5123 (requiring FINRA members selling securities issued by non-members in a private placement to file the private placement memorandum, term sheet or other offering documents with FINRA within 15 days of the date of the first sale of securities), and FINRA Rule 2210 (establishing pre-approval, filing, content and record retention requirements with respect to communications with retail investors) take on greater significance with the wider availability of general solicitation in private placements.  And, needless to say, both broker-dealers and investment advisers participating in offerings in conjunction with issuers relying on the new general solicitation rule will continue to be subject to FINRA or SEC rules generally prohibiting false or untrue statements.
• An issuer may verify that its investors are accredited by, among other ways, obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant that such person or entity has taken reasonable steps within the prior three months to verify that the purchaser is an accredited investor and has determined that such purchaser is an accredited investor.  The rationale behind this provision is that these third parties are all subject to various other regulatory, licensing and examination requirements.
• Broker-dealers and investment companies qualify as accredited investors under the general solicitation rule.