0SEC Proposes Rule Changes to Implement JOBS Act Mandate to Remove General Solicitation Prohibition for Rule 506 and Rule 144A Offerings

At its open meeting on August 29, 2012, the SEC voted 4-1 to issue for public comment proposed rule amendments that would eliminate the current prohibition against general solicitation or general advertising (collectively, “general solicitation”) in certain private offerings and sales relying on the safe harbor exemptions from registration pursuant to the Securities Act of 1933 (the “1933 Act”) provided by Rule 506 and Rule 144A under the 1933 Act.  Under existing Rule 506, an issuer may offer and sell securities, without any limitation on the offering amount, to an unlimited number of “accredited investors,” as defined in Rule 501(a) of Regulation D, and to no more than 35 non-accredited investors, subject to a number of conditions, among which is the requirement that neither the issuer, nor any person acting on its behalf, offer or sell the securities in question through any form of general solicitation.  Rule 144A allows for the resale of certain privately offered securities to institutional investors that meet the definition of “qualified institutional buyer” (“QIB”), provided, among other things, that offers are made only to QIBs.  Rule 506 and Rule 144A are widely used by U.S. and foreign issuers, including sponsors of privately-offered investment pools (“private funds”) to raise capital.   The rule proposal is designed to implement a directive set forth in Section 201(a) of the Jumpstart Our Business Startups Act (H.R. 3606) (the “JOBS Act”). 

Elimination of the Prohibition on General Solicitation.  The amendments would add new paragraph (c) to Rule 506, which would permit the use of general solicitation in connection with the offer and sale of securities pursuant to the Rule, provided that (i) all purchasers of the securities are (or are reasonably believed by the issuer to be) accredited investors, (ii) the issuer takes “reasonable steps” to verify that such purchasers are accredited investors, and (iii)  the offering otherwise complies with other applicable provisions of Regulation D, including Rule 501 and Rules 502(a) and 502(d).  The proposal preserves an issuer’s ability to conduct a Rule 506 offering under current paragraph (b) that (1) is not conducted through any general solicitation and (2) includes sales to no more than 35 non-accredited investors.  The proposed amendments to Rule 144A would permit securities sold pursuant to Rule 144A to be offered to persons other than QIBs, including by means of general solicitation, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs.

Verification of Accredited Investor Status.  An issuer relying on Rule 506(c) would need to take reasonable steps to verify the accredited investor status of purchasers of its securities.  The proposing release describes this process as “an objective determination, based on the particular facts and circumstances of each transaction.”  The SEC envisions an issuer considering a number of factors when determining what steps would be reasonable to verify that a purchaser is an accredited investor.  The proposing release provides the following examples of such factors, each of which it discusses in some depth:  (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 (including reliance on trusted third parties); 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 a minimum investment amount.   The proposing release notes that the SEC considered but determined not to propose required methods of verification, and for similar reasons, has not proposed a non-exclusive list of specified methods for satisfying the verification requirement.  The proposing release highlights the importance to an issuer of creating adequate records that document its efforts to verify accredited investor status.  The proposing release states the SEC’s intention “to monitor and study the development of verification practices by issuers, securities intermediaries and others as well as the impact of compliance with this requirement on investor protection and capital formation.” 

Private Funds.  In the proposing release, the SEC reaffirmed its historic view that by conducting an offering under Rule 506, a private fund has met the requirement that it not conduct a public offering in order to fall within the exclusions provided by Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, as amended.  The proposing release interprets Section 201(b) of the JOBS Act, where it states that “[o]ffers and sales exempt under [Rule 506, as revised pursuant to Section 201(a)] shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation,”  as permitting a private fund to rely on either Section 3(c)(1) or 3(c)(7) even though it has made a general solicitation under Rule 506(c).

Form D Amendment.  To assist the SEC in monitoring the various aspects of this rulemaking, the proposed amendments include a change to Form D that would add a separate field or check box where an issuer would indicate whether it is claiming an exemption under Rule 506(c).

Commissioner Dissent.  Citing concerns about investor protection, Commissioner Aguilar voted against the proposed amendments.  In a statement issued following the meeting, Commissioner Aguilar described additional elements he believed should have been part of the proposal: (1) amendments to the definition of accredited investor to require consideration of an investor’s financial sophistication and (2) changes to Form D requirements to enhance the timing and content of Form D reporting.  Commissioner Aguilar also cited other potential reforms put forward in comment letters submitted in anticipation of this rulemaking.  Although they voted in favor of the proposal, in statements made during the open meeting, Commissioners Gallagher and Paredes expressed dissatisfaction with the rulemaking process, particularly the decision not to issue an interim final rule given the Commission’s failure to meet the statutory deadline for rulemaking.

Request for Public Comment. The proposing release seeks public comment on various aspects of the proposed amendments.  Commissioner Aguilar’s statement includes a separate request for comment on a range of specified issues.  Comments must be submitted by the thirtieth day after the publication of the proposing release in the Federal Register.

0SEC Staff Issues Answers to Frequently Asked Questions on Effect of JOBS Act On Activities by Research Analysts

On August 22, 2012, the SEC’s Division of Trading and Markets issued a set of answers to frequently asked questions (“FAQs”) concerning the application of Section 105 of the Jumpstart Our Business Startups Act (“JOBS Act”) to emerging growth companies in the context of (1) research analyst communications, (2) quiet periods for research reports around offerings and the termination of lock-up periods, and (3) prospectus delivery pursuant to Rule 15c2-8 under the Securities Exchange Act of 1934 during the period following the filing of a registration statement by an emerging growth company that is testing the waters.  The FAQs also cover additional related issues.

Continued Applicability of Global Settlement

In 2003 and 2004, twelve investment banks entered into uniform agreements to settle enforcement actions brought by the SEC, self-regulatory organizations and state securities regulators relating to conflicts of interest between the firms’ research and investment banking functions.  These agreements, referred to as the Global Settlement, include undertakings that govern the activities of the firms where conflicts between the research and investment banking functions were thought to occur.  Over the years, the undertakings (contained in “Addendum A” to the settlements) have been amended by the court at the request of the parties.  In its response to Question 2 of the FAQs, the SEC confirmed that the JOBS Act does not amend or modify the Global Settlement.  Any amendment or modification would have to be approved by the court.  However, the SEC noted that the Global Settlement does provide that a provision of the Global Settlement can be modified or removed if the SEC adopts a rule (or approves an SRO rule) “with the stated intent to supersede” that provision.

Communications Between Research Analysts and Other Firm Personnel

Section 105(b) of the JOBS Act amended Section 15D of the Securities Exchange Act of 1934 to insert a new subsection (c) providing that neither the SEC nor any national securities association (i.e., FINRA) may adopt or maintain any rule or regulation in connection with an initial public offering of the common equity of an emerging growth company (1) restricting, based on functional role, which associated persons of a broker-dealer may arrange for communications between a securities analyst and a potential investor or (2) restricting a securities analyst from participating in any communications with the management of an emerging growth company that is also attended by any other associated person of the broker-dealer whose function is other than as a securities analyst.

In its response to Question 10, the SEC provided the following guidance with respect to Section 105(d):Prospectus Delivery Under Rule 15c2-8(e)

As noted above, clause (2) of amended Section 15D(c) now provides that SEC and SRO rules may not prohibit analysts from attending meetings with company management in the presence of investment banking personnel in connection with the IPO of an emerging growth company.  In the response to Question 4 of the FAQs, the SEC made clear that the restrictions of the Global Settlement continue to apply.  Those restrictions are quite strict.  For example, in its letter to Cleary Gottlieb dated November 2, 2004, providing guidance on the Global Settlement, the SEC noted that, even if a company asks a firm’s investment banking department to arrange a meeting with a research analyst of the firm or give the research analyst a “heads up” that the company intends to call, the Global Settlement would prohibit the investment banking department from making such a call to the research analyst (Question 18 of the 11/2/04 letter).  In the current FAQs the SEC did, however, state that firms not subject to the Global Settlement may permit research analysts and investment banking personnel to attend meetings with company management, provided that the firm’s personnel do not otherwise violate the intent of the research analysts rules.  This would happen if, for example, investment banking personnel at the meeting attempted to influence the research analyst’s views or recommendations.

The SEC made clear that Section 105(b)(2) of the JOBS Act does not affect the provisions in NASD Rule 2711(c)(5)(A) and (B) and NYSE Rule 472(b)(6)(i)(a) that prohibit analysts from participating in roadshows or otherwise engaging in communications with investors about an investment banking transaction in the presence of investment bankers or the company’s management (Question 5).

Quiet Periods on Publication or Distribution of Research Reports

Section 105(d) of the JOBS Act provides that neither the SEC nor FINRA may adopt or maintain any rule or regulation prohibiting a broker-dealer from publishing or distributing any research report or making a public appearance with respect to the securities of an emerging growth company either:

  1. within any prescribed period of time following the initial public offering date of the company or
  2. within any prescribed period of time prior to the expiration date of any agreement between the broker‑dealer and the company or its shareholders that restricts or prohibits the sale of securities held by the company or its shareholders after the initial public offering date.
  • Although the JOBS Act does not specifically address the publication or distribution of research before the waiver or termination of a lock-up agreement, the SEC considers that the Act should be read to permit the publication and distribution of research during those periods, as well as before the expiration of a lock-up agreement.
  • The SEC believes that the policies underlying Section 105(d) apply as well to the publication or distribution of research after expiration, termination or waiver of lock-up agreements, and to quiet periods after a secondary offering of an emerging growth company’s securities.  The SEC understands that FINRA is considering filing a proposal to eliminate the remaining quiet periods imposed by NASD Rules 2711(f)(1), (2) and (4) and NYSE Rules 472(f)(1) through (4) with regard to an emerging growth company and its securities.

Section 105(c) of the JOBS Act allows emerging growth companies to continue to “test the waters” after a registration statement has been filed under the Securities Act.  However, Rule 15c2-8(e) states that it is a deceptive act or practice for a broker-dealer to participate in a distribution of securities with respect to which a registration statement has been filed unless the broker-dealer takes reasonable steps to make a copy of the preliminary prospectus available to each of the broker-dealer’s associated persons who are expected, prior to the effective date, to solicit customers’ orders for such securities before sales efforts by such associated persons.  In response to Question 1, the SEC stated that underwriters taking non-binding indications of interest from customers would not be “soliciting customers’ orders” within the meaning of Rule 15c2-8(e).  The SEC further noted that submitting a confidential draft registration for staff review in accordance with Rule 106(a) of the JOBS Act does not constitute a “filing” of a registration for purposes of Rule 15c2-8(e).

Other Guidance

The SEC provided the following additional guidance:

  • The SEC considers that Sections 105(b) and (d) of the JOBS Act were intended to apply to NYSE Rule 472 to the same extent as to NASD Rule 2711.  (Question 6)
  • The SEC does not consider the JOBS Act to affect the application of the SRO rules with respect to: the supervision, compensation or evaluation of analysts (Question 7), the prohibition on pre-publication review of research reports by non-research personnel or an emerging growth company (Question 8), or the prohibition on promises of favorable research in exchange for the business of, or compensation from, an emerging growth company.  (Question 9)
  • The JOBS Act does not affect the analysis of the types of communications that constitute a research report for purposes of SEC Regulation AC (Question 11) and does not affect Regulation AC in any other respect.  (Question 12)
  • The JOBS Act does not impact any of the requirements under NASD Rule 2210 relating to communications with the public.  (Question 13)  NASD Rule 2210 and its interpretive memorandums will be replaced by new FINRA Rules 2210 and 2212-2216 in February 2013.

0SEC Staff Risk Alert on Pay-to-Play Prohibitions under MSRB Rules Includes Observations on Overall Pay-to-Play Compliance Measures

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a National Examination Risk Alert summarizing the findings of OCIE’s National Examination Program with respect to compliance by broker-dealers and municipal securities dealers with MSRB rules governing contributions to the political campaigns of public officials of municipal securities issuers with whom the firms are doing or seek to do business.  The Risk Alert describes (a) the requirements of MSRB Rules G-37 and G-38 (on which the SEC modeled Rule 206(4)-5, the pay-to-play rule under the Investment Advisers Act of 1940),  (b) specific issues under Rule G-37 and G-38 noted by the National Examination Program and (c) the OCIE staff’s observations regarding the steps taken by firms to ensure that their compliance programs adequately address not only pay-to-play obligations under MSRB rules but also under other federal, state and local requirements related to bidding for government business, election law, employment law and privacy requirements.

Look-Back/Look-Forward Requirements. An important factor noted by OCIE is the application of the look-back and look-forward periods for political contributions by municipal finance professionals (“MFPs”).  For most MFPs the look-back period is two years, although for persons who are MFPs solely because of supervisory or management-level activities, the period is shortened to six months.  The look-forward provision in the definition of MFP requires firms to count, for purposes of Rule G-37, contributions made by an individual for one year after he or she ceases to engage in the activities or hold the position that created the individual’s MFP status. Firms need to have procedures in place to make sure they do not do business with municipal entities within the relevant look-back period in the event that political contributions were made by an individual prior to employment by the firm or prior to becoming engaged in activities that caused the individual to be designated an MFP, and must continue to track contributions by MFPs not otherwise engaged in municipal business during the one year look-forward period until their MFP status is terminated. 

0Federal Banking Agencies Publish Proposed Revised Regulatory Capital Rules and Final Market Risk Capital Rules in Federal Register

The OCC, FRB and FDIC (the “Agencies”) are seeking public comment on three notices of proposed rulemaking (“NPRs”) that would revise and replace the Agencies’ regulatory capital rules and that were discussed in the June 12, 2012 Financial Services Alert.  The NPRs were published in the August 30, 2012 edition of the Federal Register and comments are due by October 22, 2012.

The Agencies also published their final market risk capital rules (the “Final Rules”) in the August 30, 2012 edition of the Federal Register.  The Final Rules were also discussed in the June 12, 2012 Financial Services Alert.  The Final Rules become effective on January 1, 2013.

0Goodwin Procter Alerts: Final Rules on Conflict Minerals Disclosures and Payment Disclosure by Resource Extraction Issuers

Goodwin Procter’s Business Litigation, Corporate, Technology Companies, Capital Markets and Environmental practices issued the following Client Alerts discussing SEC rulemaking that implements two mandates under the Dodd-Frank Act: Goodwin Procter Alert: SEC Issues Final Rule on Conflict Minerals Disclosures and Goodwin Procter Alert: SEC Final Rule: Payment Disclosure by Resource Extraction Issuers.

0UK Financial Services Authority Issues Consultation on the Restriction of the Promotion of Unregulated Collective Investment Schemes to Retail Investors

The Financial Services Authority (the “FSA”) has issued Consultation Paper CP12/19 that will have significant consequences for all FSA, authorized firms that promote, offer or advise on unregulated collective investment schemes (“UCISs”) in the United Kingdom with retail clients.  It is important to note here that, although the FSA refers to “ordinary retail investors” in the consultation paper, the term “retail client” in the FSA Rules is much wider than just unsophisticated small investors but extends to include most individual investors, even many high net worth sophisticated investors. 

The Current Position

Under the current FSA rules and UK legislation, UCISs may be promoted to investors only in  limited circumstances.  There is, helpfully, a blanket exemption for offers to FSA authorized firms (such as banks, brokers, and investment managers) and to high value corporates, partnerships and trusts.

The position for promotions to individuals is, however, more complex.  In very broad terms, UCISs that consist mainly of securities issued by unlisted companies (in other words, effectively private equity funds) may be promoted to high net worth individuals (people with either an income of more than £100,000 or net assets of more than £250,000) and to certain sophisticated investors, provided that the certification and risk warning process set out in the legislation is followed.  This is essentially a bureaucratic process, but is not difficult to comply with.

Other UCISs, such as hedge funds and real estate funds, may be promoted to individuals only in circumstances where an FSA authorized firm confirms either that the investment is a suitable investment for that client or the firm confirms that the relevant investor understands the risks in investing in such schemes.  It is this exemption set out in Rule 4.12 of the FSA COBS Rules that is the subject of this consultation (for the sake of convenience, these two exemptions are referred to as the “Suitability Exemptions”).

The FSA Proposals

The FSA has frequently warned firms that they seem to either misunderstand the operation of UK restrictions or have inadequate compliance procedures to show that the relevant exemptions are available in relation to particular promotions.  The FSA has undertaken a number of disciplinary actions against various firms recently for breaches of these rules.

These warnings do not appear to have been adequately followed by firms, as a result of which the FSA is now making the following proposals:

  1. The FSA proposes to delete the Suitability Exemptions.  This will mean that, in relation to retail clients, firms will not be able to offer or advise on UCISs except using the private equity exemptions referred to above.  It is not surprising that the FSA has taken some action in relation to UCISs since it gave warning that it would do so when issuing the recent guidance on the promotion of life settlements funds to UK investors.  What is surprising here is that the FSA has gone further than it did in that guidance in not merely warning firms that such investments are usually not suitable for retail clients but has specifically now proposed banning such offers.
  2. The FSA is proposing to extend this ban to UCIS substitutes such as securities issued by special purpose vehicles (“SPVs”) where the SPV itself provides a broadly equivalent pooling investment to a UCIS.  The current draft rules do not extend this restriction further to include, for example, securities issued, or derivatives offered, by banks that provide returns calculated by reference to a specific underlying fund.  The specific extent of this prohibition is subject to review, though, and is subject to change. 
  3. Firms will be required to improve compliance procedures when using the promotion exemptions that will continue to exist when making a promotion to retail clients.  In particular, a record will need to be kept for all promotions showing how the complies with the exemptions.


Clearly, the main consequence will be that many promotions to retail clients will be prohibited, and no relevant exemption will be available.  Firms, however, that deal with sophisticated and high net worth individual investors will need to look carefully at the new draft rules to see to what extent promotions may continue to be made to them.  There are certain possibilities:

  • The FSA proposals do not affect promotions to professional clients.  The FSA rules contain procedures for upgrading retail clients to professional client status.  In very brief terms, while it will often be difficult to upgrade clients when carrying on MiFID services such as providing advice to clients (such as in the service provided by UK-registered independent financial advisers (“IFAs”)), firms providing non-MiFID services, such as distributors, may well be able to upgrade many of their more sophisticated individual investors.
  • The statutory exemptions for high net worth and self-certified sophisticated investors in relation to private equity funds and the (FSA firm) certified sophisticated investor exemption for all UCISs will continue in place.  This would allow, for example, a manager of a UCIS to market a fund to a potential investor whose IFA has certified him to be a sophisticated investor in accordance with the procedure set out in the Financial Promotion Order. 
  • Investment in UCISs where the investor has genuinely sought out the fund himself and where no promotion has been made will not be restricted by the FSA proposals.  This will certainly be an important point for managers and distributors, although no firm will be able to build a business plan on it.


The consultation period ends on November 14, 2012, with the final rules expected during the course of the first quarter of 2013.

0NFA Proposes Registration Requirement for “Swaps Firms”

The National Futures Association (the “NFA”) submitted to the CFTC a proposal to amend the NFA’s Bylaws and Registration Rules to require any futures commission merchant, introducing broker, commodity pool operator, or commodity trading advisor that engages in activities involving swaps subject to the CFTC’s jurisdiction to seek NFA approval to act as a “swaps firm.”  Under the proposal, an individual who engages in swaps activities on behalf of a swaps firm would have to be approved by the NFA as a “swaps associated person,” and at least one of the firm’s principals would have to be approved as a swaps associated person for the firm to be approved as a swaps firm. 

A swaps associated person would not be required to pass the Series 3 examination (also known as the National Commodity Futures Examination), or any other proficiency exam, if the person’s covered activities are limited to those involving swaps.  The NFA explained in the notes accompanying the proposal that none of the existing proficiency examinations test knowledge relevant to swaps activities.  The NFA stated that it had not ruled out creating such an examination, but would not make a decision on that issue until it had more experience with its members’ swaps activities.  The proposal became effective September 1, 2012.

0CFTC Approves Final Rule Imposing Standards for Swap Dealers and Major Swap Participants

The CFTC approved a final rule that, among other things, (1) prescribes standards for swap dealers and major swap participants related to the timely and accurate confirmation of swaps, (2) requires the reconciliation and compression of swap portfolios, (3) requires timely resolutions of valuation disputes, and (4) sets forth requirements for documenting the trading relationship between swap dealers, major swap participants, and their counterparties.  The final rules release addressed elements of three different rule proposals.  In response to comments on the proposals, the final rule mandates compliance only with respect to swaps entered into after the relevant compliance dates. 

The rule also defers from October 15, 2012 to January 1, 2013 the compliance dates for some (but not all) of the rules regarding business conduct standards applicable to swap dealers and major swap participants.  The rules for which compliance is so delayed include: (a) the requirement to establish certain general policies and procedures to ensure compliance; (b) “know your counterparty” rules; (c) rules requiring the verification of certain counterparty information; (d) certain notification and disclosure requirements; and (e) requirements for swap dealers acting as advisors or counterparties to “special entities.”

The final rule will become effective 60 days after its forthcoming publication in the Federal Register.