At its open meeting on July 10, 2013, the SEC voted 4-1 to adopt final amendments that 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 “Securities Act”) provided by Rule 506 and Rule 144A under the Securities Act. Rule 506 and Rule 144A are widely used by U.S. and foreign issuers, including sponsors of privately-offered investment pools to raise capital. The final amendments are designed to implement a directive in Section 201(a) of the Jumpstart Our Business Startups Act (H.R. 3606) (the “JOBS Act”).
In conjunction with adopting the final amendments, the SEC also proposed amendments to Regulation D, Form D, and Rule 156 under the Securities Act that are part of a coordinated initiative on the part of various branches of the SEC to analyze the market impact of, and market practices that develop as result of, permitting general solicitation in connection with private offerings under new Rule 506(c). The proposed amendments and related initiative are discussed here.
Goodwin Procter has issued a client alert that addresses the final amendments from the perspective of private fund managers and a client alert that addresses the impact on operating company issuers of the final amendments and related SEC rulemaking action regarding private offerings.
Elimination of Prohibition on General Solicitation
The amendments add to Rule 506 a new paragraph (c), which permits the use of general solicitation in connection with the offer and sale of securities pursuant to the Rule, provided that (i) all purchasers of securities are accredited investors, (ii) the issuer takes “reasonable steps” to verify that purchasers are accredited investors, and (iii) the offering complies with the other applicable requirements of Regulation D. (Under Rule 501, the definition of “accredited investor” includes persons whom the issuer reasonably believes come within any of the enumerated categories of accredited investor at the time of the sale of the securities to that person.) The amendments leave unchanged existing paragraph (b) of Rule 506 that permits an issuer to 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 506(b) will not require the issuer to undertake the verification process mandated under Rule 506(c).
Rule 144A currently 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. The final amendments to Rule 144A will 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) must take reasonable steps to verify the accredited investor status of purchasers of its securities. An issuer must satisfy this requirement even if all purchasers are in fact accredited investors. The adopting release describes this process as “an objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction.” The adopting release provides the following factors that issuers should consider, and discusses how they may affect an issuer’s determination of accredited investor status in particular situations: (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 and terms of the offering, such as the manner in which the purchaser was solicited to participate in the offering, or the existence and magnitude of a minimum investment amount.
The adopting release notes that the SEC determined not to require particular methods of verifying accredited investor status. The final amendments do, however, include a non-exclusive list of four specified methods for satisfying the verification requirement:
- verifying whether a natural person is an accredited investor on the basis of income through reliance on a combination of tax reporting forms and written investor representations;
- verifying whether a natural person is an accredited investor on the basis of net worth through reliance on (a) recent statements from financial institutions, tax assessments, and third party appraisals, and a recent credit report, and (b) related investor representations;
- relying on a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such party has verified the accredited investor status of the investor within the past three months; and
- relying on an accredited investor representation from a natural person investor who invested prior to the effective date of Rule 506(c) as an accredited investor in a Rule 506(b) offering by the issuer and has maintained that holding.
The adopting release makes clear that in each case “self-accreditation” by an investor, e.g., a check-the-box representation in a subscription agreement, without more, will not meet the Rule 506(d) verification requirement. The adopting release highlights the importance of creating records that adequately document an issuer’s efforts to verify accredited investor status.
Private Fund Offerings
In the adopting release, the SEC reaffirmed its view that by conducting an offering under Rule 506, a private fund has met the condition to the exclusions provided by Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 that it not conduct a public offering. The SEC also reminded advisers to private funds that they are subject to Rule 206(4)-8 under the Investment Advisers Act of 1940, a broad anti-fraud rule governing their relationship with current and prospective private fund investors, and that the SEC has brought enforcement actions against private fund advisers and others under Rule 206(4)-8 for material misrepresentations regarding matters such as fund performance, strategy, and investments.
Form D Amendment
The final amendments include changes to Form D that add a separate check box where an issuer can indicate that it is relying on Rule 506(c) and revise the name of the check box currently labeled “Rule 506” to read “Rule 506(b).” The adopting release notes that an issuer may not check both the Rule 506(b) and Rule 506(c) boxes at the same time for the same offering.
Non-Integration with Offshore Offerings
In the adopting release, the SEC reaffirmed its view expressed in the release proposing the amendments that a concurrent offering relying on Regulation S under the Securities Act will not be integrated with domestic offerings under amended Rule 506 (including new Rule 506(c)) or amended Rule 144A.
Effectiveness and Transition
The final amendments are effective 60 days after their publication in the Federal Register. For an offering that was already underway, the issuer may choose to continue the offering after the effective date in accordance with the requirements of either Rule 506(b) or Rule 506(c). If an issuer chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales in reliance on Rule 506(b) that occurred prior to the effective date. Similarly, for an ongoing Rule 144A offering that commenced before the effective date of the final amendments, offering participants will be entitled to conduct the portion of the offering following the effective date using general solicitation, without affecting the availability of Rule 144A for the portion of the offering that occurred prior to the effective date of the final amendments.