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. As amended, Rule 506 will 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 requires the SEC to adopt rules implementing these amendments to Rule 506. The JOBS Act also states that“[s]uch rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”
Although the terms “general solicitation” and “general advertising” are not defined in Regulation D, Rule 502(c) does provide examples of general solicitation and general advertising, including advertisements published in newspapers and magazines, communications broadcast over television and radio, and seminars whose attendees have been invited by general solicitation or general advertising. By interpretation, the SEC has confirmed that other uses of publicly available media, such as unrestricted websites, also constitute general solicitation and general advertising.
On August 29, 2012, in SEC Release No. 33-9354, the SEC issued proposed JOBS Act regulations which, when finalized, will allow issuers to use general solicitation and advertising in private placements so long as all of the purchasers are accredited investors. Specifically, to implement the mandated rule change, the SEC proposed new Rule 506(c), which 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.
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 proposed 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.
Unfortunately, the proposed Rule does 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 will be that an issuer will 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. Because there is no safe harbor, this will 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. And although the Rule change is not final, and is subject to SEC review of extensive public comments, this writer believes it doubtful that the proposed rule will be changed in any material respect when issued in final form.
All issuers should bear in mind that until final rules are issued, no public solicitations or advertising are permitted in a private placement.
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.