On August 29, 2012, the U.S. Securities and Exchange Commission (SEC) issued for public comment a proposal to eliminate the prohibition against general solicitation and general advertising contained in Regulation D (Regulation D) under the U.S. Securities Act of 1933, as amended (1933 Act), for offerings relying on Rule 506 of Regulation D (Rule 506) provided that all purchasers of the securities are accredited investors. In order to use general solicitation and general advertising for such Rule 506 offerings, the issuer would be required to take reasonable steps to verify that the purchasers of the securities are accredited investors. The SEC also proposed to amend Rule 144A under the 1933 Act (Rule 144A) to provide that securities may be offered under Rule 144A to persons other than qualified institutional buyers provided that the securities are only actually sold to persons that the seller and any person acting on behalf of the seller reasonably believe are qualified institutional buyers. Issuers relying on other U.S. private placement exemptions, such as transactions not involving a public offering under Section 4(a)(2) of the 1933 Act, Rules 504 and 505 of Regulation D or Rule 506(b) offerings that include non-accredited investors, will still have to abide by the prohibition on general solicitation and general advertising (which we refer to in this Update as general solicitation). The proposed rule is intended to implement Sections 201(a)(1) and (2) of the Jumpstart Our Business Startups Act (JOBS Act), which directs the SEC to permit general solicitation in certain Rule 506 and Rule 144A offerings. The proposed rule will remain open for comments until October 5, 2012.
Noteworthy for Canadian companies that make Canadian offerings in reliance on Regulation S under the 1933 Act (Regulation S) concurrently with U.S. private placements in reliance on Rule 506 or Rule 144A, is that in discussing the proposed rule changes, the SEC's release confirms its historical guidance that a U.S. offering employing general solicitation will not be integrated with a concurrent offering under Regulation S. Although the SEC does not expressly confirm that general solicitation will not constitute "directed selling efforts" (a restriction on publicity in the United States in connection with an offering under Regulation S that is similar in effect to the historical ban on general solicitation), we are hopeful that market participants will interpret the SEC's comments as having that effect. If so, Canadian issuers conducting cross-border offerings involving Rule 506 or Rule 144A private placements (as each will be amended when the SEC's final rule becomes effective) in the United States would be able to relax the restrictions on communications about their offerings in the United States that must currently be imposed. We anticipate that some comment letters on the proposed rule will seek further clarification from the SEC.
Issuers are also reminded that until the SEC adopts final amendments to the rules following the comment period, offerings conducted in the United States under Rule 506 and Rule 144A continue to be subject to the prohibition on general solicitation.
Rule 506 Offerings
Rule 506 is a safe harbor under an exemption from the registration requirements of the 1933 Act that permits an issuer to offer and sell securities without any limitation on the offering amount to an unlimited number of "accredited investors" as defined in Regulation D and to no more than 35 non-accredited investors who meet certain sophistication requirements. One of the conditions to the use of the Rule 506 exemption has been that the issuer or any person acting on the issuer's behalf not offer or sell securities through any form of "general solicitation" or "general advertising" within the meaning of Regulation D. While general solicitation is not specifically defined in Regulation D, examples are provided such as advertisements published in newspapers and magazines, communications broadcast over television and radio, and seminars whose attendees have been invited by general solicitation. The SEC has also considered other forms of public communications, such as unrestricted websites, to be forms of general solicitation.
Conditions for the Use of General Solicitation in Proposed Rule 506(c)
To implement the changes required by the JOBS Act, the SEC is proposing to create a new Rule 506(c)1, which would permit (but not require) general solicitation in connection with Rule 506 offerings provided that:
- the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors;
- all purchasers of the securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities; and
- all terms and conditions of Rule 501 (defines categories of persons that are accredited investors) and Rule 502(a) (addresses concerns regarding integration of offerings made within six months of each other) and Rule 502(d) (imposes resale limitations on securities sold under Regulation D) are satisfied.
Issuers satisfying these criteria would, among other things, be permitted to issue press releases in the United States about the Rule 506 offering, post details to their company websites, participate in conferences during the pendency of the offering, and refer to the offering in RSS feeds.
Verification of Accredited Investor Status
While the proposing release contains extensive discussion regarding various actions that might constitute reasonable steps to verify accredited investor status, the proposed rule does not specify any particular criteria. The SEC also declined to provide a non-exclusive list of adequate verification measures due to concerns that there may be circumstances where the types of information contained on such a list would not actually verify accredited investor status or may cause the issuer to overlook or disregard information indicating that a purchaser is not in fact an accredited investor. Instead, in order to preserve flexibility, the SEC indicated that whether the steps taken are "reasonable" would be an objective test, based on the particular facts and circumstances of each transaction. The proposed rule indicates that some of the factors that issuers could consider include:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the issuer has about the purchaser; and
- the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.
The SEC anticipates that many of the steps used in connection with current Rule 506 offerings would satisfy the proposed verification requirement. However, the SEC cautioned that using a check box in a questionnaire to verify accredited investor status of new investors (with whom there is no pre-existing relationship) who participate in an offering as a result of a general solicitation would not be a reasonable verification step absent other information about that investor's accredited investor status. As a result of the objective nature of the reasonableness of the verification, issuers should retain adequate records documenting the steps taken to verify that a purchaser was an accredited investor.
Form D Check Box
The proposed rules would also amend Form D, which is the filing required to be made with the SEC and applicable state securities regulators notifying them of the use of Regulation D for a registration exempt offering. The change to Form D would add a separate check box requiring issuers to indicate whether they have used general solicitation or general advertising for their Rule 506(c) offerings. The SEC indicated that this change will allow it to monitor the extent of the use of the liberalized communications abilities for Rule 506(c) offerings and the size of the offering market.
Rule 144A Offerings
Rule 144A is an exemption from the registration requirements of the 1933 Act for resales of privately placed securities to qualified institutional buyers (QIBs). Rule 144A is commonly used in private placement transactions where an investment bank acts as the initial purchaser of securities from the issuer in reliance on Section 4(a)(2) of the 1933 Act and then resells the securities to QIBs.
Although Rule 144A does not expressly prohibit general solicitation, offers of securities under Rule 144A currently must be limited to persons reasonably believed by the seller or any person acting on behalf of the seller to be QIBs, which has the same practical effect. In order to implement the requirements of the JOBS Act, the proposed rule would amend Rule 144A to eliminate the requirement that offers be made only to persons reasonably believed by the seller to be QIBs so long as the securities are only actually sold to purchasers that the seller or any person acting on behalf of the seller reasonably believes are QIBs. As a result, general solicitation would be permissible in Rule 144A offerings.
Privately Offered Funds
Privately offered funds, such as hedge funds, venture capital funds and private equity funds, usually rely on Section 4(a)(2) and Rule 506 in order to sell their interests to investors in the United States without registration under the 1933 Act. These funds usually also rely on one of two exclusions from the definition of "investment company" under the U.S. Investment Company Act of 1940, as amended (1940 Act), which enables them to be excluded from the regulatory provisions of the 1940 Act. Privately offered funds may not rely on the two exclusions (which are found in Sections 3(c)(1) and 3(c)(7) of the 1940 Act) if they make a public offering of their securities. The SEC confirmed in the proposing release that the use of general solicitation in connection with a Rule 506(c) offering by a private fund would not result in the loss of either of the two 1940 Act exclusions.
Treatment of Regulation S in Cross-Border Offerings
Regulation S provides an exclusion from the registration requirements of the 1933 Act for offers and sales of securities outside the United States. Issuers engaged in global offerings of securities in which the U.S. portion is conducted in reliance on Rule 506 or Rule 144A typically rely on Regulation S for the non-U.S. portion of the offering. In addition, most issuers making a Canadian offering with no concurrent U.S. registered offering will, from a U.S. securities law perspective, rely on Regulation S so as to conclude that no registration is required under the 1933 Act for the Canadian offering.
Two general conditions apply to the use of Regulation S (with additional conditions potentially applying based on the facts and circumstances of the issuer and the type of offering): (1) the securities must be sold in an "offshore transaction"; and (2) there can be no "directed selling efforts" in the United States (in each case as defined in Regulation S). The prohibition on directed selling efforts has historically been viewed as the functional equivalent of the prohibition on general solicitation in that directed selling efforts is defined in Regulation S as "any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities offered in reliance on Regulation S. Such activity includes placing an advertisement in a publication 'with a general circulation in the United States' that refers to the offering of securities being made in reliance upon Regulation S."
In light of the similarity between the concepts of directed selling efforts in Regulation S and general solicitation in Rule 506 and Rule 144A, several commenters had requested that the SEC clarify that issuers conducting an international offering in reliance on Regulation S and a concurrent U.S. private placement in reliance on Rule 506 or Rule 144A that includes permitted general solicitation will not violate the prohibition on directed selling efforts. Otherwise, the issuer could trigger a 1933 Act registration requirement for the non-U.S. sales due to activities that are permissible in the context of the U.S. private placement sales. Although the SEC did not expressly address this potential inconsistency, it did reiterate its long standing view, stated in its adopting release for Regulation S in 1990, that "[o]ffshore transactions made in compliance with Regulation S will not be integrated with registered domestic offerings or domestic offerings that satisfy the requirements for an exemption from registration under the  Act."
We are hopeful that market participants will interpret the SEC's confirmatory statements as consistent with its historical view stated in the adopting release for Regulation S in 1990 that "[l]egitimate selling activities carried out in the United States in connection with [registered or exempt] offerings will not constitute directed selling efforts with respect to offers and sales made under Regulation S" and, accordingly, conclude that general solicitation, as will be permitted in a U.S. offering under Rule 144A or Rule 506(c) after the SEC issues final rules, will not constitute directed selling efforts for the purposes of a concurrent offering under Regulation S.
1 Rule 506 offerings that include sales to a limited number of non-accredited investors have been preserved under existing Rule 506(b), which continues to contain a prohibition on general solicitation.
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