Alert July 23, 2013

SEC Proposes Additional Reporting and Disclosure Requirements for Private Offerings, Describes Plan to Monitor Impact of Permitting General Solicitation in Private Offerings

In conjunction with creating a new category of private offering in Rule 506(c) of Regulation D under the Securities Act of 1933 (the “Securities Act”) that permits an issuer to engage in general solicitation and general advertising, the SEC also proposed amendments to Regulation D, Form D, and Rule 156 under the Securities Act (the “Proposed Amendments”).  The SEC’s adoption of Rule 506(c) is discussed here.  Goodwin Procter has also issued a client alert that discusses the operating company perspective on the proposed amendments, as well as the adoption of Rule 506(c) and related SEC rulemaking action regarding private offerings.

At this point, the additional requirements discussed in this article are only proposals; any changes to Regulation D, Form D, and Rule 156 will be adopted only after the SEC has had the opportunity to consider public comment on the Proposed Amendments.

The Proposed Amendments would:

  1. require an issuer conducting a Rule 506(c) offering to file Form D before engaging in general solicitation;
  2. require an issuer to file a closing amendment to Form D after the termination of a Rule 506 offering;
  3. disqualify an issuer from relying on Rule 506 for one year for future Rule 506 offerings (whether under Rule 506(b) or 506(c)) if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with the Form D filing requirements for a Rule 506 offering;
  4. require an issuer to provide additional information about Regulation D offerings;
  5. require written general solicitation materials used in a Rule 506(c) offering to include certain legends and other disclosures, some specific to the presentation of performance data for private funds (i.e., funds that rely on either Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act of 1940);
  6. for a two-year period following adoption, require issuers to file with the SEC on a non-public basis written general solicitation materials used in Rule 506(c) offerings; and
  7. disqualify an issuer from relying on Rule 506 if the issuer, or any predecessor or affiliate of the issuer were subject to an injunction for failure to comply with the proposed disclosure and temporary filing requirement for general solicitation materials in the Proposed Amendments.

The Proposed Amendments would also extend to private funds the anti-fraud guidance regarding sales literature that Rule 156 currently provides with respect to registered investment companies.

The Proposed Amendments are part of a broader effort by 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).  This initiative will be a coordinated effort on the part of various branches of the SEC (the “Rule 506(c) Work Plan”), including the Office of Compliance Inspections and Examinations (“OCIE”) and the Division of Enforcement.

Form D – Filing Prior to General Solicitation 

The Proposed Amendments would require an issuer to file an “Advance Form D” no later than 15 calendar days before the first use of general solicitation in a Rule 506(c) offering.  In an Advance Form D, an issuer would be required to respond to only some of the Form D items.  The issuer would subsequently have to file an amendment providing the remaining information required by Form D within 15 calendar days after the date of first sale of securities in the offering.

Form D – Filing After Rule 506 Offering Terminates 

The Proposed Amendments would require an issuer to file a closing Form D amendment within 30 calendar days after it terminates a Rule 506 offering (whether under Rule 506(b) or involving general solicitation under Rule 506(c)).

Form D – Disqualification from Rule 506 Offerings for Failure to File 

The SEC is not proposing to make Form D filing a condition of Rule 506.  The Proposed Amendments would, however, revise Rule 507 of Regulation D so that an issuer would automatically be disqualified for one year from relying on Rule 506 for any new offering (whether under Rule 506(b) or 506(c)) if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the past five years, with the Form D filing requirements of Rule 503 with respect to a Rule 506 offering.  The one year period would start upon the filing of all required Form D filings or, if the offering had been terminated, upon the filing of a closing amendment.  Disqualification would arise only with respect to Rule 503 non-compliance that occurred after the effectiveness of the proposed disqualification provision.  The proposed disqualification provision would be in addition to the existing Rule 507 disqualification from Rule 504, 505 and 506 exemptions that arises when an issuer is subject to an injunction for failure to comply with the Form D filing requirement of Rule 503.

The proposed disqualification would not apply to offerings of an issuer or an affiliate that are ongoing at the time of the non-compliance with Rule 503, including the offering for which the issuer failed to make a required filing.  Those offerings could continue to rely on Rule 506 as long as the conditions of Rule 506 continue to be met; disqualification would apply only to future offerings.

A disqualification from using Rule 506 for future offerings would be subject to a 30 day cure period that would be available only for the first failure to file in any offering.  In addition, under the Proposed Amendments a proposed disqualification would be subject to the existing provision of Rule 507 that permits the SEC to waive a disqualification under the rule if it determines “upon a showing of good cause, that it is not necessary under the circumstances that exemption be denied.”

Form D – Additional Information Requirements

The Proposed Amendments would make a number of changes to specific items in Form D, some of which would apply not only to offerings under Rule 506, but also to those under Rules 504 and 505 and Section 4(5) of the Securities Act.  These changes include providing (a) information about persons controlling the issuer and (b) for Rule 506 offerings, information on (i) the number of accredited investors and non-accredited investors that purchased in an offering, (ii) whether they are natural persons or legal entities, and (iii) the amount raised from each category of investors.  The Proposed Amendments would also add new items that would apply to all Rule 506 offerings, and in some cases would be specific to Rule 506(c) offerings, seeking the  following information:

  • the number and types of accredited investors that purchased securities in the offering (e.g., natural persons who qualified as accredited investors on the basis of income or net worth);
  • if a class of the issuer’s securities is traded on a national securities exchange, ATS or any other organized trading venue, and/or is registered under the Securities Exchange Act of 1934 (the “Exchange Act”), the name of the exchange, ATS or trading venue and/or the Exchange Act file number, and whether the securities being offered are of the same class or are convertible into or exercisable or exchangeable for that class;
  • if the issuer used a registered broker-dealer in connection with the offering, whether any general solicitation materials were filed with FINRA;
  • if the issuer is a pooled investment fund, the name and SEC file number of each registered investment adviser or exempt reporting adviser advising the fund that also acts as a promoter;
  • for Rule 506(c) offerings, the types of general solicitation used or to be used (e.g., mass mailings, emails, public websites, social media, print media and broadcast media); and
  • for Rule 506(c) offerings, the methods used or to be used to verify accredited investor status.

Written General Solicitation Materials - Legends and Disclosure

Under the Proposed Amendments, new Rule 509 would require all written general solicitation materials to include the following legends “in a prominent manner”:

  • The securities may be sold only to “accredited investors,” which for natural persons are investors who meet certain minimum annual income or net worth thresholds;
  • The securities are being offered in reliance on an exemption from the registration requirements of the Securities Act and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act;
  • The Commission has not passed upon the merits of or given its approval to the securities, the terms of the offering, or the accuracy or completeness of any offering materials;
  • The securities are subject to legal restrictions on transfer and resale and investors should not assume they will be able to resell their securities; and
  • Investing in securities involves risk, and investors should be able to bear the loss of their investment.

Private Funds - Written General Solicitation Materials 

Under the Proposed Amendments, new Rule 509 would require a private fund’s written general solicitation materials to include a legend stating that the securities offered are not subject to the protections of the Investment Company Act.

Private Funds - Written General Solicitation Materials with Performance Data

Under the Proposed Amendments, private fund performance data in written general solicitation materials would have to be as of the most recent practicable date “considering the type of private fund and the media through which the data will be conveyed,” and must include the period for which performance is presented.  The performance data would have to be accompanied by either a telephone number or a website for obtaining current performance data.  A private fund would not be expected to value its portfolio for the sole purpose of providing updated current performance under proposed Rule 509.  Performance data would be current if it were as of the last date on which the private fund customarily valued its holdings.

Under proposed Rule 509, written general solicitation materials for a private fund with performance data that does not reflect the deduction of fees and expenses  would have to disclose that fees and expenses have not been deducted and that if such fees and expenses had been deducted, performance may be lower than presented.

Under proposed Rule 509, written general solicitation materials for a private fund that include performance data would also have to include the following legends (which are similar to those required in advertisements and other sales materials of registered investment companies by Rule 482 under the Securities Act):

  • performance data represents past performance;
  • past performance does not guarantee future results;
  • current performance may be lower or higher than the performance data presented;
  • the private fund is not required by law to follow any standard methodology when calculating and representing performance data; and
  • the performance of the fund may not be directly comparable to the performance of other private or registered funds.

The proposing release notes that the SEC has “determined not to propose standardized calculation methodologies for performance of private funds without further study.”  The release does, however, request comment on whether to prohibit or restrict the use of performance data, and whether other manner and content restrictions for written general solicitation materials would be appropriate.

Written General Solicitation Materials - Temporary Filing Obligation

Under the Proposed Amendments, temporary Rule 510T would require an issuer conducting a Rule 506(c) offering to file any written general solicitation materials prepared by it or on its behalf no later than the date the materials are first used in the offering.   Materials filed pursuant to Rule 510T would not be publicly available on the SEC website, and would not be not be treated as being “filed” or “furnished” for purposes of the Securities or Exchange Acts, including their liability provisions.  Rule 510T would expire two years after its effective date.

Disqualification from Rule 506 Offerings – Non-Compliance with General Solicitation Legending, Disclosure, and Filing Requirements

The SEC is not proposing to make compliance with Rule 509 disclosure obligations and Rule 510T filing obligations a condition of the applicable Regulation D or Section 4(a)(5) exemptions.  The Proposed Amendments would, however, revise Rule 507(a) to disqualify an issuer from relying on Rule 506 if the issuer, or any predecessor or affiliate of the issuer, were subject to an injunction for failure to comply with the new disclosure requirements in Rule 509 or the temporary filing requirement for general solicitation materials in Rule 510T.

Application of Rule 156 Anti-Fraud Guidance to Private Funds

The Proposed Amendments would revise Rule 156 under the Securities Act, which provides guidance on the types of information in investment company sales literature that could be misleading for purposes of the federal securities laws, e.g., Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, so that the Rule would apply to private funds.  Rule 156 lists (a) general factors that could cause a statement about an investment company to be misleading and (b) circumstances in which (i) representations about an investment company’s past or future investment performance or (ii) statements involving a material fact about the characteristics or attributes of an investment company, could be misleading.

Rule 506(c) Work Plan

As discussed in the proposing release, the Rule 506(c) Work Plan will evaluate the use of Rule 506(c) by issuers and market participants, and, in particular, the steps they take to verify that the purchasers of the offered securities are accredited investors.  Under the Rule 506(c) Work Plan, the SEC staff will, among other things:

  • evaluate the range of purchaser verification practices used by issuers and other participants in Rule 506(c) offerings, including whether these verification practices are excluding or identifying non-accredited investors;
  • evaluate whether the absence of the prohibition against general solicitation has been accompanied by an increase in sales to non-accredited investors;
  • assess whether the availability of Rule 506(c) has facilitated new capital formation or has shifted capital formation from registered offerings and unregistered non-Rule 506(c) offerings to Rule 506(c) offerings;
  • examine the information on Rule 506(c) offerings submitted or available to the SEC, including the information in Form D filings and the form and content of written general solicitation materials;
  • monitor the market for Rule 506(c) offerings for increased incidence of fraud, and to assist with this effort, develop risk characteristics regarding the types of issuers and market participants that conduct or participate in Rule 506(c) offerings and the types of investors targeted in those offerings;
  • incorporate an evaluation of the practices in Rule 506(c) offerings in the staff’s examinations of registered broker-dealers and registered investment advisers; and
  • coordinate with state securities regulators on sharing information about Rule 506(c) offerings.

Definition of Accredited Investor

The proposing release notes that in light of public comment on the definition of accredited investor, the SEC has begun a review of the definition of accredited investor as it relates to natural persons, including the need for any changes to this definition following the effectiveness of Rule 506(c).  The SEC expects to coordinate this review with (1) the review of the accredited investor definition in its entirety that Section 413(b) of the Dodd-Frank Act requires it to undertake four years after enactment and (2) the Dodd-Frank Act mandated study regarding the appropriate criteria for determining the financial thresholds or other criteria for qualifying as an accredited investor that the GAO is required to submit by July 20, 2013.

Due Date for Public Comment 

Comments on the Proposed Amendments must be received by the SEC no later than 60 days after the proposing release is published in the Federal Register.