SEC Amends Regulation D to Permit General Solicitation & General Advertising in Connection with Rule 506 Offerings
July 16, 2013
On July 10, 2013, the SEC adopted amendments to Regulation D under the Securities Act of 1933, as amended (“Securities Act”), to permit general solicitations and general advertising in private offerings under Rule 506 provided all purchasers in the offering are “accredited investors” and the issuer takes reasonable steps to verify that purchasers are accredited investors. In the same release, the SEC adopted certain amendments to Rule 144A that are not covered by this client alert.
The rule amendments were adopted to implement Section 201(a)(1) of the Jump Start Our Business Startups Act of 2012.
The amendments to Regulation D become effective 60 days after publication in the Federal Register.
Amendments to Regulation D
Rule 506 of Regulation D is a non-exclusive safe-harbor under Section 4(a)(2) of the Securities Act which exempts transactions by an issuer not involving a public offering from the registration requirements of the Securities Act.
Currently, an issuer relying upon Section 4(a)(2) is restricted in its ability to make public communications to attract investors because advertising is incompatible with a claim of exemption under Section 4(a)(2).
Under Rule 506, an issuer may sell securities, without limitation on the offering amount, to an unlimited number of “accredited investors” and to no more than 35 non-accredited investors who meet certain “sophistication requirements.”
Currently, the Rule 506 safe-harbor exemption is subject to a number of requirements, including that the issuer or any person acting on the issuer’s behalf not offer or sell the securities through any form of general solicitation or advertising (“general solicitation”). Rule 502(c) provides examples of general solicitation, including advertisements in published newspapers and magazines, television and radio broadcasts, and seminars where attendees are invited by general solicitation.
Rule 506 has been amended to add a new paragraph (c) which provides that the prohibition against general solicitation will not apply to a Rule 506 offering made in reliance upon the newly amended rule provided all purchasers of securities in the offering are accredited investors.
The new rule amendments permitting general solicitation will only apply to Rule 506 offerings and not Section 4(a)(2) offerings in general.
Securities issued in Rule 506(c) offerings will continue to be “covered securities” for purposes of Section 18(b)(4)(e) of the Securities Act.
Reliance upon the new Rule 506(c) requires that the following conditions be satisfied:
all terms and conditions of Rule 501 (accredited investor definition), Rule 502(a) (six month safe harbor from integration), and Rule 502(d) (securities acquired in Regulation D transaction are “restricted securities”)
all purchasers are accredited investors
the issuer takes reasonable steps to verify that the purchasers are accredited investors
Reasonable Steps to Verify Accredited Investor Status
Whether the steps taken to verify that purchasers are accredited investors are “reasonable” is to be based upon an objective determination by the issuer or anyone acting on its behalf (such as a placement agent), in the context of the particular facts and circumstances of each purchaser and transaction.
The rule requires a principles based approach to the verification process. Issuers are advised to consider certain factors when determining the reasonableness of the verification process, including the following interconnected factors:
the nature of the purchaser and type of accredited investor the purchaser claims to be
the amount and type of information the issuer has about the purchaser
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 the minimum offering amount
The adopting release provides examples of certain types of information an issuer could review and rely upon which would, depending on the circumstances, constitute reasonable verification steps, including:
publicly available information in public filings (for example, a 501(c)(3) organization’s Form 990 filed with the IRS discloses the organization’s total assets)
third party information that provides reasonably reliable information that a person falls within one of the categories in the accredited investor definition (for example, (a) the purchaser provides copies of pay stubs for the two most recent years and the current year or (b) specific information about the average compensation earned at the purchaser’s workplace by persons at the level of purchaser’s seniority is publicly available, or (c) verification of accredited investor status by a third party, provided the issuer has a reasonable basis to rely on such third-party verification)
The nature of the offering may affect the reasonableness of the verification procedures. For example, the adopting release states that an issuer who solicits through social media, print media, and the like would be obligated to take greater steps to verify accredited investor status than an issuer that solicits new investors that have been pre-screened. The SEC stated in the adopting release that an issuer is entitled to rely on third party verification provided the issuer has a reasonable basis to rely upon such third party verification. Checking a box in a questionnaire or signing a form, absent other information, will not suffice.
The terms of the offering will also affect whether verification methods are reasonable. For example, the adopting release states that a higher minimum investment could be a relevant factor. The ability of a purchaser to satisfy a minimum investment amount that is sufficiently high such that only accredited investors could reasonably be expected to meet it could be taken into account, particularly if it is a cash investment not financed by the issuer.
The amended rule includes a non-exclusive list of specific verification methods, as follows:
in verifying whether a natural person is accredited on the basis of income, an issuer will be deemed to satisfy the verification requirement by review copies of IRS Forms W-2, Forms 1099, Schedules K-1, and a copy of filed Form 1040 for the two most recent years together with written representations about a person’s reasonable expectations of reaching the income levels required to satisfy accredited investor status based upon income or joint income with that person’s spouse
in verifying whether a natural person is accredited based on net worth, an issuer will be deemed to satisfy the verification requirement by reviewing one or more of the following types of documentation, dated within the past three months and written representations that all liabilities necessary to make a determination of such status have been disclosed:
Assets: bank statements, brokerage statements, certificates of deposit, tax assessments, and third party appraisal reports
Liabilities: a credit report from at least one nationwide credit reporting agency
In addition, an issuer will be deemed to satisfy the verification requirements by obtaining a written confirmation from any one of the following third parties provided they have taken reasonable steps to verify that a purchaser is an accredited investor:
a registered broker-dealer
an SEC registered investment advisor
a licensed attorney, or
If a Rule 506 offering commenced before the removal of the ban on general solicitation, an issuer may choose to continue the offering after the effective date of the new rule under either Rule 506(b) or Rule 506(c). If an issuer chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales of securities that occurred before the effective date in reliance on Rule 506(b).
Form D Amendments
Form D has been amended to add a check box to indicate whether an issuer is claiming an exemption under Rule 506(c) in connection with the offering.
Continued Availability of Rule 506 Offerings a Without General Solicitation
As an alternative to Rule 506(c), if an issuer does not want to undertake accredited investor status verification consistent with the foregoing, the rule still permits offerings to be conducted in reliance upon Rule 506(b) provided the issuer does not engage in any general solicitation of investors or general advertising in connection with the offering.
Issues for Private Funds
Private funds, such as hedge funds, venture capital funds and private equity funds, typically rely upon Section 4(a)(2) and Rule 506 to offer and sell interests without registration under the Securities Act. In addition, private funds rely on one of two exclusions from the definition of “investment company” under the Investment Company Act of 1940, as amended (“Investment Company Act”) (either Section 3(c)(1) or Section 3(c)(7)) which enables them to be excluded from the registration and other requirements under the Act.
Private funds are precluded from relying upon either of these two exceptions if they make a public offering of their securities.
In the adopting release, the SEC expressed the view that offers and sales exempt under Rule 506 (including offerings in reliance upon Rule 506(c)) are not deemed to be public offerings under Federal securities laws as a result of general advertising and general solicitation and that private funds may conduct offerings by means of general solicitation while at the same time relying upon the exclusions from the definition of investment company under Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act.
For more information, please contact:
Neil R.E. Carr
Direct Dial: +1 202 587 2983
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