Summary
The Securities and Exchange Commission has proposed new regulations to implement provisions of the JOBS Act, eliminating prohibitions on general solicitation and advertising in certain private placement offerings to accredited investors.
On August 29, 2012, the Securities and Exchange Commission (the "Commission") proposed rules to amend Rule 506 of Regulation D ("Rule 506") promulgated under the Securities Act of 1933, as amended, to eliminate the prohibition against general solicitation and advertising in offers and sales of securities made pursuant to Rule 506 in which all purchasers of the securities are accredited investors as defined in Regulation D. While Section 201(a) of the Jumpstart Our Business Startups Act ("JOBS Act") obligated the Commission to implement the final version of this rule by July 4, 2012, the Commission has decided to propose regulations and allow for a 30-day public comment period as opposed to implementing interim final regulations.
The existing version of Rule 506 allows issuers to sell securities in a private placement offering of an unlimited offering amount to an unlimited number of accredited investors and up to 35 non-accredited investors who meet certain sophistication requirements. The safe harbor of Rule 506 is currently conditioned on the issuer not offering or selling the securities through any form of "general solicitation" or "general advertising." While these terms are not defined in Regulation D, the rules provide that print and radio advertisements and presentations at seminars whose attendees have been invited by general solicitation or advertising as examples of activities that are not currently permitted. By interpretation, the Commission has also confirmed that other uses of publicly available media, such as unrestricted websites, also constitute general solicitation and general advertising. These restrictions had the effect of limiting offers of securities in private placement offerings under Rule 506 to either persons within an issuer's business network with whom they have a pre-existing relationship or persons referred by a registered broker-dealer who was paid a commission for the referral by the issuer, thus limiting the success and/or increasing the cost of these offerings. The purpose of this provision of the JOBS Act is to remove these restrictions so that issuers can more easily identify accredited investors and raise the money they need to grow their businesses.
The proposed rule adds a new Rule 506(c) which permits the use of general solicitation to offer and sell securities under Rule 506 so long as (i) the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors, (ii) all purchasers are accredited investors either because they meet the definition in Rule 501(a) or the issuer reasonably believes that they do at the time of sale of the securities, and (iii) all terms and conditions of Regulation D other than the general solicitation restriction are satisfied. A new Rule 506(b) preserves the existing ability of issuers to conduct Rule 506 offerings without the use of general solicitation.
Whether the steps taken by the issuer are reasonable will be an objective determination, based on the facts and circumstances of each transaction. Under this approach, issuers should consider a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor.
Nature of the purchaser and the type of accredited investor he claims to be. The steps that might be reasonable to verify the accredited investor status of an entity will be different than that of an individual. For example, for an entity that claims accredited investor status as a result of being a registered broker-dealer, the issuer could verify this status on FINRA's Broker Check website. For an individual, an issuer will need to take different steps to verify accredited investor status through the income or net worth tests set forth in Rule 501 of Regulation D. The proposed rules do not change the definition of accredited investor or these tests.
Amount and type of information that the issuer has about the purchaser. The more information that an issuer has about a purchaser would be a significant factor in determining what additional information would be reasonable to verify the purchaser's accredited investor status. If an issuer has actual knowledge that the purchaser is an accredited investor, the issuer would not have to take any steps at all to verify this status. Examples of information that issuers may rely upon include publicly available information filed with federal, state or local regulatory authorities, third-party information that provides reasonably reliable evidence that a person falls within the enumerated categories in the accredited investor definition (e.g., copies of a W-2 statement, industry publications of average annual compensation for certain levels of employees) or verification of a person's status as an accredited investor by a third-party professional (e.g., account statements verified by an investor's broker), provided that the issuer has a reasonable basis to rely on such third-party verification.
Nature of the offering, such as the manner in which the purchaser was solicited, terms of the offering. If an issuer solicits a purchaser through a website that is accessible to the general public or through a widely disseminated email or social media solicitation it would need to take greater measures than an issuer that solicits investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer. A purchaser's ability to meet a high minimum investment amount requirement that only accredited investors could satisfy, without third-party financing, could require less steps to verify accredited investor status than a lower minimum investment amount would require.
Regardless of the approach used, an issuer should retain adequate records that document the particular steps taken to verify that a purchaser was an accredited investor at the time of investment. While many of the practices currently used by issuers in connection with existing Rule 506 offerings would satisfy the proposed verification requirement, the Commission believed it was necessary to provide flexibility to market participants and, therefore, did not prescribe the use of specified methods of verification. The particular facts and circumstances of each offering and each accredited investor will dictate the steps that will satisfy the reasonableness standard. The issuer must take reasonable steps to verify that the purchaser was an accredited investor and must have had a reasonable belief that such investor was an accredited investor at the time of the securities sale.
The Commission has also added a separate field or check box to Form D for issuers to indicate whether they are using general solicitation and are claiming an exemption under Rule 506(c).
While it would seem unlikely that the Commission would commence an enforcement action in such an offering sold exclusively to accredited investors that closes prior to enactment of the final rules, there can be no assurance of this fact. Accordingly, in light of the comment period set by the Commission, issuers should probably wait until the Commission issues its final rules before using general solicitation and advertising to complete private placement offerings pursuant to Rule 506. We will issue a new Alert when the Commission adopts these final rules.
