Adopts Rules to Lift the Ban on General Solicitation in Rule 506 and Rule 144A Offerings and to Disqualify “Bad Actors” from Rule 506 Offerings; Proposes Rules to Strengthen Oversight of Private Placement Market

At an open meeting on July 10, 2013, the SEC

  • adopted final rules to implement a JOBS Act requirement permitting issuers to use general solicitation and advertising in securities offerings effected in reliance on Rule 506 of Regulation D and offerings under Rule 144A;
  • adopted final rules that disqualify issuers from effecting securities offerings in reliance on Rule 506 of Regulation D in cases where the issuer or certain other persons involved in the offering have in the past been convicted of a felony or committed other “bad acts”; and
  • proposed new rules that would require issuers to provide additional information concerning Rule 506 offerings.

The adopted rules will become effective 60 days after publication in the Federal Register, and the proposed rules will undergo a 60-day public comment period.

A summary of the final and proposed rules is set forth below.

Final Rules

Eliminating the Prohibition on General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings

Companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration. Most of the exemptions from registration prohibit issuers from engaging in general solicitation or advertising in connection with securities offerings, such as advertising in newspapers or on the Internet. Rule 506 of Regulation D is the most widely-used exemption from registration and, until now, has included such prohibition on general solicitation and advertising in connection with the securities offering.

To facilitate capital raising by small businesses, Congress in the JOBS Act directed the SEC to remove the prohibition on general solicitation and advertising for offerings relying on Rule 506 provided certain conditions are met. The JOBS Act also directed the SEC to make parallel changes to Rule 144A under the Securities Act of 1933—an exemption from registration that applies to the resale of securities to larger institutional investors known as “qualified institutional buyers” or QIBs. In August 2012, the SEC issued for public comment the proposed rules to implement Section 201(a)(1) of the JOBS Act.

The final rules adopted by the SEC amend Rule 506 by adding a new paragraph (c) that will allow issuers to use general solicitation and advertising provided that

  • the issuer takes reasonable steps to verify that the investors are accredited investors;1 and
  • all investors are accredited investors (or the issuer reasonably believes that all investors are accredited investors).

The rule provides a non-exclusive, non-mandatory list of methods that issuers may use to verify an investor’s accredited status including

  • reviewing copies of any IRS form that reports the investor’s income and obtaining a written representation that the investor will likely continue to earn the necessary income in the current year;
  • reviewing copies of bank, brokerage and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports from independent third parties as evidence of the investor’s assets and, with regard to liabilities, a consumer report from at least one nationwide consumer reporting agency; and
  • receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney or CPA that such entity or person has taken reasonable steps to verify the investor’s accredited status.

Issuers that conduct offerings without general solicitation and general advertising under the existing exemption provided under Rule 506(b) are not subject to the new verification requirement.

The SEC also adopted parallel amendments to Rule 144A to remove the ban on general solicitation and advertising. However, the Rule 144A exemption will continue to be conditioned on the securities being sold only to QIBs or to purchasers that the seller and any person acting on its behalf reasonably believe to be QIBs. The amendments will not add any additional standards for determining whether a seller reasonably believes a purchaser to be a QIB or otherwise.

With respect to private funds (such as hedge funds, venture capital funds and private equity funds), the SEC confirmed that engaging in advertising under the new rules will not, in and of itself, cause funds to lose either of the exclusions under the Investment Company Act on which funds typically rely (i.e., Sections 3(c)(1) and/or 3(c)(7) of the Investment Company Act of 1940).

The SEC also amended Form D, which is the notice that issuers must file with the SEC when they sell securities under Regulation D, to add a separate box for issuers to check if they are relying on the new rules permitting general solicitation.

The final rules, available here, become effective 60 days after publication in the Federal Register, which can be expected shortly.

Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings

In connection with lifting the ban on general solicitation, the SEC also adopted amendments that disqualify securities offerings involving certain “felons and other ‘bad actors'” from reliance on Rule 506 of Regulation D. Notably, these “bad actor” disqualification provisions apply to all Rule 506 offerings, not merely offerings in which an issuer engages in general solicitation pursuant to new Rule 506(c). The SEC was required to conduct this rulemaking pursuant to Section 926 of the Dodd-Frank Act.

These “bad actor” disqualification provisions will prohibit issuers and others (such as underwriters, placement agents, promoters, and the directors, executive officers and certain other officers, and certain larger beneficial owners of the issuer) from participating in Rule 506 offerings if they have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws. The rule provides an exception from disqualification when the issuer can show it did not know and, in the exercise of reasonable care, could not have known that a “bad actor” participated in the offering. Importantly, the disqualification only applies to events that occur after the effective date of the rule, though matters that existed prior to the effective date must be disclosed to investors.

The final rules, available here, become effective 60 days after publication in the Federal Register, which can be expected shortly.

Proposed Rules

Proposed Rules to Strengthen SEC Oversight of Rule 506 Offerings

The SEC proposed several new rules and amendments to Regulation D in order to strengthen the Commission’s oversight and enhance its monitoring of the private placement market now that the ban on general solicitation has been lifted.

Under the proposals, issuers that intend to engage in general solicitation in connection with a Rule 506 offering would be required to file a Form D at least 15 days before engaging in general solicitation. This requirement would be in addition to the current requirement of filing a Form D within 15 days after the first sale of securities. Further, within 30 days of completing an offering, issuers would be required to update the information contained in the Form D and indicate that the offering has ended. Issuers would also be required to provide additional information about the offering and the parties involved, such as expanded information about the issuer, the types of investors in the offering, the methods used to verify the accredited investor status of investors, and other new information. The proposed rules would disqualify issuers who fail to file Form D within the preceding five years from using Rule 506 until one year after the required Form D filing(s) are made.

The SEC also proposed to require legends in any written general solicitation materials used and to extend guidance about misleading statements in sales literature by SEC-registered investment companies to the sales literature of private funds whether or not such funds are engaged in general solicitation activities.

Finally, the SEC proposed a temporary rule that would require that issuers relying on the new general solicitation rules submit their soliciting materials to the SEC no later than the date of first use of such materials. Materials submitted in this manner would not be available to the general public. This temporary rule would expire two years following its adoption.

Comments on the proposed rules, available here, are due within 60 days after publication in the Federal Register, which can be expected shortly.

If you have any questions regarding the issues addressed in this Corporate and Securities Law Alert, please contact any of the attorneys with whom you regularly work or any of the attorneys listed here.

1 Under existing rules, a person qualifies as an accredited investor if he or she has either: (i) an individual net worth or joint net worth with a spouse that exceeds $1 million, excluding the value (and any related indebtedness) of a primary residence; or (ii) an individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.