On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act), making sweeping changes to federal laws regulating capital formation. One of the more significant changes to existing law was a directive to the SEC to promulgate rules expanding an existing exemption from SEC registration for private placements – Rule 506 under SEC Regulation D. Amended Rule 506 would allow companies conducting unregistered private placements to solicit investors using general solicitation and general advertising so long as all of the purchasers in the offering are “accredited investors.” The JOBS Act specifically required the SEC to adopt rules implementing these amendments to Rule 506, including a rule which would require that the issuer to take “reasonable steps” to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”
On July 10, 2013, the SEC adopted final rules under the JOBS Act to lift the ban on general solicitation and advertising in private placements, a practice that, until the JOBS Act, had been generally prohibited since the federal securities laws were first adopted in 1933. These new rules go into effect in mid-September 2013.
The impact of the final SEC rule allowing general solicitation and advertising in unregistered private placements cannot be ovcrstated. It will certainly have a dramatic positive impact on the ability of issuers to both raise capital and to reduce costs associated with raising capital. The rule change is expected to be particularly helpful for startup companies, emerging private companies and small public companies which generally have greater difficulty accessing capital markets.
In view of the dramatic and far reaching impact of this rule change (and the potential further rule changes announced in the companion SEC release discussed below) on expanded access of public and private companies to capital markets without engaging in an expensive and time consuming SEC registration, look for additional articles covering this topic in the coming weeks and months. In the meantime, following is a brief summary of the new Rule and the related newly proposed rule.
Final SEC Rule Allowing Public Solicitation and Advertising in Private Placements
On August 29, 2012, in SEC Release No. 33-9354, the had SEC issued proposed JOBS Act regulations which, if adopted, would allow issuers to use general solicitation and advertising in private placements so long as all of the purchasers are accredited investors. Specifically, as proposed by the SEC, Rule 506(c) would permit the use of general solicitations to offer and sell securities under Rule 506, provided that the following conditions are satisfied:
- the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors;
- all purchasers of 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 other terms and conditions of Rule 506 are satisfied.
On July 10, 2013, the SEC the adopted a final rule allowing an issuer to engage in public solicitation and public advertising in private placements. The final rule, as adopted, is substantially identical to the rule as proposed, with one notable exception: the SEC has added non-exclusive “safe harbor” provisions intended to provide some degree of certainty to an issuer that it has taken “reasonable steps” to verify that all purchasers are accredited investors, at least in the case of investors who are individuals (as opposed to entities such as corporations and LLC’s).
According to the SEC’s proposing Release, whether an issuer has taken “reasonable steps” to verify the accredited status of an investor would require an objective analysis, which in turn would depend on the particular facts and circumstances of each transaction. In the view of the SEC, this approach would require an issuer to consider a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor. Some examples of factors cited as relevant by the SEC in determining whether an issuer has taken “reasonable steps” 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 Rule, as originally proposed, did not provide any “safe harbor” to allow an issuer protection in its belief that it took reasonable steps to verify that a purchaser is an accredited investor. The result would have been that an issuer would not have the benefit of any certainty that it has complied with the Rule change allowing public solicitation in a private placement if it turns out that one or more of the investors was not in fact an accredited investor, even if the issuer has acted in good faith. As pointed out by this author in The Corporate Securities Lawyer Blog article published on October 24, 2012, the absence of a safe harbor would likely force the issuer to either (i) take greater steps than it might otherwise take to verify “accredited investor status,” which would likely entail additional time and expense, or (ii) avoid the use of public solicitation in a private placement altogether.
In response to these concerns, expressed by a number of commentators, the final rule adopted on July 10, 2013, provides a safe harbor for specific, non-exclusive methods to measure the reasonableness of the steps taken to verify that individual investors are accredited investors:
- Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year; and
- Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
The final rule is effective 60 days after being published in the Federal Register (effective on or about mid-September 2013). Until the effective date issuers may not rely on the new rule provisions allowing public solicitation. The adopting SEC release, Release No. 33-9415, which contains over 100 pages, is available to the public on the SEC’s website, www.sec.gov ( http://www.sec.gov/rules/final/2013/33-9415.pdf).
Proposed SEC Rules Governing Private Placements
In a companion release (SEC Release No. 33-9416) (http://www.sec.gov/rules/proposed/2013/33-9416.pdf) issued on July 10, 2013, the SEC announced additional proposed amendments to Rule 506. According to the SEC, the proposed amendments are intended to enhance the SEC’s ability to evaluate the development of market practices in Rule 506 offerings and to address concerns that may arise in connection with permitting issuers to engage in general solicitation and general advertising under the newly amended Rule 506. The proposed amendments would require:
- the filing of a Form D in a Rule 506 offering involving public solicitation and advertising before the issuer engages in general solicitation;
- the filing of a closing amendment to Form D after the termination of any Rule 506 offering;
- written general solicitation materials used in Rule 506 offerings to include certain legends and other disclosures;
- the submission to the SEC, on a temporary basis, of written general solicitation materials used in Rule 506 offerings to the SEC.
The proposed rule would also disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering. The proposed amendments would also require an issuer to include additional information in Form D about offerings conducted in reliance on Regulation D.
This author expects that many of the provisions in the proposed rule will ultimately be adopted by the SEC in final form. Given that the proposed rules are intended primarily to facilitate oversight by the SEC of the newly expanded Rule 506 allowing public solicitation and advertising and to identify patterns of fraud or abuse, it is likely that the SEC will give a high priority to the promulgation of these rules in final form. Given the breadth of the 186 page Release proposing the rule changes, specific details of the proposed rule will be addressed in subsequent articles.
About the Author – Samuel S. Guzik is a corporate and securities attorney and business advisor admitted to practice before the SEC and in New York and California, with over 30 years of experience. During this time he has represented a number of public and privately held businesses, from startup to exit, concentrating in financing startups and emerging growth companies. For additional information regarding Mr. Guzik and his firm, Guzik & Associates, please visit his website at www.guziklaw.com.