Alert September 04, 2012

SEC 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.