Last week, the U.S. Securities and Exchange Commission (the "SEC") proposed amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 (the "Securities Act") to implement Section 201(a) of the Jumpstart Our Business Startups Act (the "JOBS Act").
As required by the JOBS Act, the proposed rule amendments will permit the use of "general advertising" and "general solicitation" (for example, newspaper or magazine ads, television or radio broadcasts and publicly available websites) in unregistered securities offerings conducted in accordance with Rule 506 or Rule 144A. This type of activity is currently (and has been for many years) prohibited under these rules, and this prohibition has become a fundamental aspect of how private offerings are conducted in the United States. Permitting the use of general advertising and general solicitation in private offerings may have a significant effect on how private placements are conducted in the United States, especially for private companies and small public companies who are more likely to change their capital raising marketing efforts following the adoption of the final amendments.
Rule 506 of Regulation D provides a safe harbor from the registration requirements of the Securities Act, and is relied on extensively by U.S. and non-U.S. issuers in conducting private, i.e., non-registered, offerings of securities in the United States, generally, although not always, exclusively to "accredited investors." Similarly, Rule 144A provides a safe harbor for primary non-registered offerings made by issuers through financial intermediaries (usually called "initial purchasers") to large institutional investors called "qualified institutional buyers" ("QIBs").
The proposed rule amendments will permit the use of general advertising and general solicitation in offerings under new Rule 506(c), subject to issuers taking reasonable steps to verify that all purchasers in the offering are accredited investors.1 Whether the steps taken will be "reasonable" will be an objective determination, based on the facts and circumstances of each offering.2 Without specifying any particular measures that should be taken, the SEC suggested that the reasonableness of an issuer's verification efforts will depend on various factors, including:
- the nature of the purchaser and the type of accredited investor the purchaser claims to be;
- the amount and type of information the issuer has about the purchaser; and
- the nature and terms of the offering.
The proposed rules retain the current definition of "accredited investor" in Rule 501, which, in addition to persons who actually are accredited investors, includes persons the issuer "reasonably believes" to be accredited investors. By requiring issuers to take reasonable steps to verify accredited investor status, issuers will, in many if not most cases, have to make additional efforts to support such a reasonable belief (currently most issuers rely on self-verification by investors through the use of investor questionnaires). Regardless of the particular steps taken, issuers should retain adequate records that document the steps taken to verify that a purchaser is an accredited investor because issuers claiming an exemption from registration have the burden to show that they are entitled to rely on the exemption claimed.
The rule proposal retains the current version of Rule 506, i.e., an offering conducted without general advertising or general solicitation, for issuers that prefer not to engage in any general solicitation and thus not be required to make any additional investor verification efforts. The SEC is also proposing to amend Form D, the notice required to be filed with the SEC by each issuer claiming a Regulation D exemption, to add a separate field or check box to indicate whether an offering is being conducted under proposed new Rule 506(c). In addition to monitoring the use of general solicitation in these types of offerings and the size of this offering market, this proposed change to Form D will enable the SEC to look into the practices that issuers develop to satisfy the accredited investor verification requirement.
The proposed rules would also permit the use of general advertising and general solicitation in Rule 144A offerings provided that sales of securities are made only to QIBs or persons reasonably believed to be QIBs. The proposed rules do not make any changes to the ways currently set forth in the rule by which sellers may determine a potential investor's status as a QIB.
Of particular interest to non-U.S. issuers is the SEC's statement in the proposing release that the use of general advertising or general solicitation in a Rule 506 or Rule 144A offering will not cause the U.S. offering to be integrated with an offering being conducted simultaneously outside the United States pursuant to Regulation S under the Securities Act. Issuers will thus be able to conduct unregistered offerings offshore and inside the United States concurrently without fear of losing either exemption.
The SEC confirmed in the proposing release that private investment companies (generally, hedge funds, venture capital funds and private equity funds) that typically rely on Rule 506 for their securities offerings, will not be precluded from relying on the exclusions set forth in Sections 3(c)(1) (for "100 person funds") and 3(c)(7) (for "qualified purchaser funds") of the Investment Company Act of 1940, by reason of using general advertising or general solicitation in their Rule 506 offerings.
As stated in the proposing release, the amendments proposed by the SEC are limited to those that, in the SEC's view, are strictly necessary to implement the mandate in Section 201(a) of the JOBS Act. Accordingly, the SEC did not address a number of related issues, including for example the interaction of the proposed rule amendments with existing regulatory restrictions on marketing efforts by commodity pool operators, commodity trading advisors and registered investment advisers.
1 As is currently the case under the existing regime in Rule 506 offerings, securities acquired under the new rule would be "restricted securities" subject to the resale limitations set forth in Rule 502(d) of Regulation D.
2 The SEC decided not to propose requiring issuers to use specified methods of verification claiming that it would be "impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor, as well as the potentially wide range of verification issues that may arise" in any particular offering.
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