SEC Lifts Ban on General Solicitation
and Issues Disqualification Rules for "Bad
Actors" in Certain Private
Offerings
By Michael
Meskill and Andrew
Solomon
On July 10,
2013, the Securities and Exchange Commission
(the "SEC") adopted new rules to implement
certain requirements of the Jumpstart Our
Business Startups Act of 2012 and the Dodd-Frank
Wall Street Reform and Consumer Protection
Act. These new rules amend the SEC
requirements for private offerings by:
- Allowing issuers of securities in Rule 506
private offerings to promote the offering
through general solicitation and advertising;
- Allowing sellers to sell securities under
Rule 144A, including by means of general
solicitation, to qualified institutional
buyers1
("QIBs") or purchasers that the seller
reasonably believes are QIBs; and
- Disqualifying certain issuers from relying
on the Rule 506 exemption if the issuer or any
other person covered by the rule had a
"disqualifying event."
In connection
with these new rules, the SEC also proposed
amendments to Form D that would require issuers
to provide additional information about their
private offerings and subject issuers to
stricter penalties for failure to comply with
the requirements.
General
Solicitation in Rule 506 Offerings
Issuers seeking
to raise capital through the sale of securities
have done so by either (1) a public sale through
a registered offering or (2) a private sale
through an exemption from the registration
requirements of the Securities Act of
1933. According to the SEC, Rule 506 is by
far the most widely used exemption under
Regulation D.2 Historically,
under Rule 506, issuers have been prohibited
from advertising the offering to the general
public (e.g., through newspapers, television,
unrestricted websites and social
media).
Under new Rule
506(c), an issuer is permitted to engage in
general solicitation and advertising for a Rule
506 offering so long as:
- All purchasers are accredited investors (or
the issuer reasonably believes they are
accredited);
- The issuer takes reasonable steps to verify
the purchasers are accredited investors; and
- All terms and conditions of Rule 501
(definitions under Regulation D), Rule 502(a)
(integration), and Rule 502(d) (private resale
restrictions) are satisfied.
Under new Rule
506(c), to determine whether the accredited
investor verification steps are reasonable, the
SEC has adopted a "principles-based"
approach. This approach requires that an
issuer make an objective determination of
whether its verification steps are reasonable in
light of (1) the nature of the purchaser and the
type of accredited investor that the purchaser
claims to be, (2) the amount and type of
information that the issuer has about the
purchaser, and (3) 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
investment amount (if any). After
consideration of the facts and circumstances of
the purchaser and the transaction, the more
likely it appears that a purchaser qualifies as
an accredited investor, the fewer steps the
issuer would have to take to verify accredited
investor status, and vice versa.3
Issuers
should retain adequate records regarding the
steps taken to verify that a purchaser is an
accredited investor. The SEC does not
believe an issuer has taken reasonable steps to
verify accredited investor status if the issuer
requires only that a person check a box in a
questionnaire or sign a form (absent other
information indicating accredited investor
status).
In addition to
the "principles-based" approach, Rule 506(c)
also provides a non-exclusive list of four
methods that issuers may use to satisfy the
verification requirements with respect to
individuals:
- For the income test, reviewing copies of the
individual's IRS forms that report income for
the past two years (e.g., Form W-2,
1099, or 1040 or Schedule K-1) and obtaining a
written representation that the individual has a
reasonable expectation of reaching the income
level necessary during the current year;
- For the net worth test, reviewing one or
more of the following types of documents, dated
within the prior three months, and by obtaining
a written representation from the individual
that all liabilities necessary to make a
determination of net worth have been
disclosed. For assets: bank
statements, brokerage statements, and other
statements of securities holdings, certificates
of deposits, tax assessments and appraisal
reports issued by independent third parties are
deemed to be satisfactory; and for liabilities,
a consumer or credit report from one of the
nationwide consumer reporting agencies is
required;4
- Receiving written confirmation from a
registered broker-dealer, an SEC-registered
investment adviser, a licensed attorney or a
certified public accountant that such person or
entity has taken reasonable steps to verify that
the individual is an accredited investor within
the prior three months and has determined that
such purchaser is an accredited investor; and
- If the individual previously participated in
a Rule 506 offering by the issuer as an
accredited investor and remains an investor of
the issuer, obtaining a certification from the
individual that at the time of sale such
individual qualifies as an accredited investor.
None of the four methods will satisfy the
verification requirement if the issuer has
knowledge that the purchaser is not an
accredited investor.
The new
verification rules only apply to issuers who are
using general solicitation and advertising in
connection with their Rule 506
offering. Issuers will continue to have the
ability under Rule 506(b) to conduct Rule 506
offerings subject to the historical general
solicitation prohibition, in which case issuers
will not be subject to the new verification
requirements.
Rule
144A
Securities can
be sold under Rule 144A, including by means of
general solicitation, so long as the securities
are sold to a QIB or to a purchaser the seller
reasonably believes is a QIB. The general
solicitation permitted in Rule 144A resales by
the initial purchaser(s) to the QIBs will not
affect the availability of the Section 4(a)(2)
exemption from registration for the initial sale
of the securities by the issuer to the initial
purchaser(s).
Disqualification
of Bad Actors
Under new Rule
506(d), the Rule 506 exemption is not available
to an issuer if the issuer or any other "covered
person" related to the issuer experiences a
"disqualifying event."
Under the new
rule, a "disqualifying event" includes the
following:
- Criminal convictions, court injunctions and
restraining orders involving certain securities
matters;
- Final orders from certain financial
regulators that bar certain conduct;
- Certain SEC disciplinary orders, cease and
desist orders and stop orders;
- Suspension or expulsion from membership in,
or association with a member of, a
self-regulatory organization; and
- U.S. Postal Service false representation
orders.
"Covered
persons" include the issuer, any predecessor and
affiliated issuers, and the following:
- Directors, executive officers, other
officers participating in the offering, general
partners and managing members of the issuer;
- 20% or more beneficial owners of the issuer,
calculated based on voting power;
- Promoters of the issuer;
- Investment managers of issuers that are
pooled investment funds as well as any general
partner or managing member of such investment
manager, and any directors, officers and other
officers participating in the offering of such
investment manager or general partner or
managing member of such investment manager; and
- Persons compensated (directly or indirectly)
for soliciting investors as well as the general
partner or managing member of such solicitor,
and any directors, executive officers and other
officers participating in the offering of such
solicitor or general partner or managing member
of such solicitor.
Rule 506(d) will not apply if the issuer can
show it did not know and, in the exercise of
reasonable care, could not have known that a
disqualification existed.
Issuers will
not be disqualified from using Rule 506 as a
result of disqualifying events that occurred
before the effective date of new Rule
506(d). However, issuers must disclose
these pre-rule disqualifying events to investors
(unless the issuer did not know, and in the
exercise of reasonable care could not have
known, of the existence of the disqualifying
events). The SEC expects issuers to give
reasonable prominence to the disclosure.
Proposed
Amendments to Regulation D and Form
D
In connection
with the new SEC rules, the SEC proposed
additional rules that, if adopted, would require
more information from issuers relying on the
Rule 506 exemption and provide stricter
penalties for noncompliance. The proposed
rules would require issuers to file a Form D at
least 15 days before
engaging in any general solicitation for a Rule
506(c) offering and, within 30 days of
completing the offering, file a Form D amendment
to update the information and indicate the
offering has ended.5 Additionally,
the current Form D would be amended to require
additional information from the issuer such as
(1) identification of the issuer's website, (2)
information about the offered securities and the
types of general solicitation used in the
offering, (3) information about the use of
proceeds from the offering, and (4) expanded
information about the issuer and the types of
investors.
Under the
proposed rules, an issuer would be disqualified
from using the Rule 506 exemption in future
offerings if the issuer did not comply with the
proposed Form D filing requirements. The
ban would last for one calendar year after the
issuer files the required Form D filings.
The SEC is
accepting comments to the proposed rules for a
60-day period.
Jackson
Walker's Corporate
and Securities attorneys have extensive
experience in all areas of securities law
compliance. For more information regarding
compliance with Rule 506 or any other related
issue, please contact your Jackson Walker
attorney or any one of the following Jackson
Walker attorneys:
Austin Elise
Green - 512.236.2028 -
egreen@jw.com Michael
F. Meskill - 512.236.2253 - mmeskill@jw.com
Dallas Richard
F. Dahlson -
214.953.5896 - rdahlson@jw.com Byron
F. Egan - 214.953.5727 - began@jw.com Alex
Frutos - 214.953.6012 - afrutos@jw.com Jeffrey
M. Sone - 214.953.6107 - jsone@jw.com Kevin
Jones - 214.953.6129 - kjones@jw.com
Houston Jeff
Harder - 713.752.4346 - jharder@jw.com Richard
S. Roth - 713.752.4209 - rroth@jw.com
San Antonio
Stephanie
L. Chandler - 210.978.7704 - schandler@jw.com Steven
R. Jacobs - 210.978.7727 - sjacobs@jw.com
1A
qualified institutional buyer is a type of
institutional investor that owns and invests on
a discretionary basis at least $100 million in
securities of issuers not affiliated with the
investor.
2According
to the SEC, Rule 506 accounts for an estimated
90% to 95% of all Regulation D offerings and the
overwhelming majority of capital raised in
Regulation D offerings.
3For
example, if the terms of the offering require a
high minimum investment amount and a purchaser
is able to meet those terms, then the likelihood
of that purchaser satisfying the definition of
accredited investor may be sufficiently high
such that, absent any facts that indicate that
the purchaser is not an accredited investor, it
may be reasonable for the issuer to take fewer
steps to verify or, in certain cases, no
additional steps to verify accredited investor
status other than to confirm that the
purchaser's cash investment is not being
financed by a third party.
4The
SEC noted that (a) each of the credit reporting
agencies must provide a person with a free copy
of his or her consumer report upon request once
every 12 months and (b) third parties can access
individual consumer reports with the written
permission of the individual.
5Current
SEC rules only require that a Form D be filed
within 15 days after
the first sale of securities in a private
offering. |