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SEC Repeals Ban on General Solicitation and Proposes Significant Changes to Rule 506 Offerings

Securities Alert | July 15, 2013
By: Lori S. Smith, Neil P. Casey, Merritt A. Cole

On July 10, 2013, the SEC issued long-awaited final rules lifting the prohibition on general solicitation and general advertising in securities offerings under Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 (the Securities Act), as mandated by Section 201(a) of the Jumpstart Our Business Startups Act (the JOBS Act). The SEC also adopted final rules prohibiting issuers from relying on Rule 506 if certain felons and other “bad actors” are participating in the offering, as mandated by Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). Additionally, the SEC issued proposed rules that would impose significant new filing and disclosure requirements in connection with Rule 506 offerings and modify or enhance penalties for failure to make required filings in connection with such offerings.[1]

Set forth below is a brief summary of certain key provisions of the final and proposed rules. A future Client Alert will address in detail the practical impact of the new rules on various types of issuers, as well as certain potential implications of the proposed rules.

Repeal of Ban on General Solicitation

Rule 506(c) Offerings. The final rules adopted by the SEC include new Rule 506(c), which permits an issuer to engage in general solicitation and/or general advertising in offering and selling securities pursuant to Rule 506 provided that, among other things, all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors.[2] The existing Rule 506(b) safe harbor, with its prohibition on general solicitation and general advertising, will continue to be available to issuers who do not wish to generally solicit accredited investors or who wish to accept up to 35 non-accredited investors in their private offerings as currently permitted.

It is important to note that Rule 506(c) will not take effect until 60 days after publication in the Federal Register (i.e. mid-September). Prior to this effective date, issuers are not permitted to engage in general solicitation and general advertising in reliance on Rule 506(c). Also, even after the new rule becomes effective, issuers relying on Section 4(a)(2) of the Securities Act (the traditional statutory exemption for private placements) outside of Rule 506(c) will continue to be subject to the prohibition on general solicitation and general advertising .

In its adopting release, the SEC stated that the test of whether the verification steps taken by an issuer in a Rule 506(c) offering are reasonable will be an objective “principles-based” 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 release sets forth a number of factors an issuer should consider in making this determination, including 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 the minimum investment amount.

While Rule 506(c) does not set forth general safe harbors or an exclusive list of methods for establishing whether verification steps are reasonable, it does include a non-exclusive list of methods that issuers may use to satisfy the accredited investor verification requirements for purchasers that are natural persons, including obtaining IRS forms, bank statements, publicly available salary information and third-party credit reports, or a written confirmation from a registered broker-dealer, an SEC-registered investment advisor, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor. The SEC’s inclusion of this non-exclusive list of verification methods for natural person investors is one of the most significant differences between Rule 506(c) as initially proposed and finally adopted.

In the adopting release, the SEC noted that an issuer will not lose its ability to rely on Rule 506(c) for a securities offering if a non-accredited investor actually participates in the offering, so long as the issuer has taken reasonable steps to verify that all purchasers are accredited investors and the issuer has a reasonable belief that all purchasers are accredited investors. The SEC also reaffirmed its view that private funds are permitted to engage in general solicitation in compliance with new Rule 506(c) without losing their exclusion from the definition of “investment company” under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act.

Rule 144A Offerings. The final rules amend Rule 144A to provide that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers as defined in the Rule (QIBs), 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. In other words, a Rule 144A offering can be made via general solicitation or general advertising, so long as the actual purchasers of the securities are limited in this manner.

Form D Amendments. The final rules also revise Form D, which is the notice required to be filed with the SEC by each issuer claiming an exemption from registration pursuant to Regulation D, to require issuers to indicate whether they are relying on Rule 506(c) by checking a box on the revised Form.

The final rules and adopting release also contain certain other clarifying amendments and comments by the SEC.

Disqualification of Felons and Bad Actors from Rule 506 Offerings

In a separate release, the SEC adopted final rules amending Rule 506 to implement Section 926 of the Dodd-Frank Act and disqualify issuers from relying on Rule 506 if certain felons and other “bad actors” are participating in the offering. Those covered by the rule include the issuer, its predecessors and affiliated issuers, as well as directors and certain officers, general partners, and managing members of the issuer, 20 percent beneficial owners of the issuer, promoters, investment managers and principals of pooled investment funds, and persons compensated for soliciting investors, as well as the general partners, directors, officers, and managing members of the investment manager or compensated solicitor.

The final rules include an exception from disqualification if the issuer establishes that it did not know, and in the exercise of reasonable care could not have known, that a disqualifying condition existed. In order to rely on this exception, an issuer will be required to establish that it has made a factual inquiry into whether a disqualifying condition exists, the nature and scope of which may vary based on the facts and circumstances concerning the issuer and other offering participants. Additionally, the rules contemplate that the SEC could waive a disqualification upon showing of good cause.

Proposed Rules Relating to Form D Notice and Disclosure

The SEC also proposed rules which would impose significant new notice and disclosure requirements on certain securities offerings under Rule 506 and impose or enhance penalties for failing to make required filings.

Form D Requirements. Among other things, these proposed rules would require all issuers relying on Rule 506(c) to file an advance notice of sale (an Advance Form D) with the SEC at least 15 calendar days prior to the first use of general solicitation or general advertising in such offering. The SEC indicated that it does not anticipate that its staff will review each Advance Form D filing as it is being made but is intended as a way to enhance the information available to the SEC to analyze offerings under Rule 506(c).

After filing an Advance Form D, the issuer would then be required to file an amendment with the remaining information required by Form D within 15 days after the date of first sale of securities in the offering as currently required by Rule 503. Also, within 30 days of completing the offering, the issuer would be required to update the information contained in the Form D and indicate that the offering had ended.

The proposed rules also would amend Form D to require additional information concerning the issuer, any website utilized by the issuer, the offered securities, the types of investors in the offering, the use of proceeds of the offering, the types of general solicitation and general advertising used and the methods used to verify the accredited investor status of the investors.

Disqualification for Failure to File. The proposed rules would disqualify issuers from using the Rule 506 exemption in any new offering (whether the issuer utilizes general solicitation or not) if the issuer or its affiliates has failed comply with the Form D filing requirement in a Rule 506 offering. The disqualification period would continue for one year following the date on which the required Form D filings are made. Issuers would be able to rely on a cure period for a late Form D filing, and in certain circumstances, could request a waiver from the staff. The SEC noted that an issuer that was disqualified from using the Rule 506 exemption by virtue of this rule would not be prohibited from relying on any other available exemption.

Mandatory Legends and Disclosures. The proposed rules also would require issuers to include legends and certain cautionary disclosures in written general solicitation materials advising potential investors of the potential risks of the investment. If the issuer is a private fund and includes information about past performance in its written general solicitation materials, it would be required to provide additional information to highlight the limitations on the usefulness of this type of information and the difficulty of comparing this information with past performance information of other funds. These proposed disclosure requirements would apply to private funds regardless of whether such funds engaged in general solicitation or advertising, and are already applicable to the sales literature of registered investment companies.

Submission of General Solicitation Materials to SEC. Finally, the proposed rules would require issuers to submit written general solicitation materials to the SEC through an intake page on the SEC website no later than the date of the first use of these materials in general solicitation or general advertising. Materials submitted in this manner would not be publicly available and would not be treated as being filed or furnished for purposes of the Securities Act or the Securities Exchange Act of 1934. This submission process is proposed to be temporary and expire in two years.

Request for Comments on Accredited Investor Definition. The SEC stated in the proposing release that it has also begun review of the definition of accredited person as it relates to natural persons, including whether this definition should be amended following the effectiveness of Rule 506(c), and specifically requested comments on this as well as certain other issues related to Rule 506.

The SEC indicated that it would monitor the Rule 506 market to analyze the development of market practices in response to the final rules and proposed rules (if adopted), as well as the impact of these rules on investor protection and capital formation. As noted above, the final rules will become effective 60 days after publication in the Federal Register. The proposed rules are subject to a 60-day public comment period following such publication.

For more information regarding this Client Alert, please contact Lori Smith (212.714.3075; smithl@whiteandwilliams.com) or Neil Casey (212.631.4414; caseyn@whiteandwilliams.com) in our New York office, or Merritt Cole (215.864.7018; colem@whiteandwilliams.com) in our Philadelphia office.


[1] The SEC’s final and proposed rules, and accompanying SEC releases, can be found at http://www.sec.gov/rules/final/2013/33-9415.pdf (repeal of general solicitation ban); http://www.sec.gov/rules/final/2013/33-9414.pdf (disqualification of felons and bad actors from Rule 506 offerings); and http://www.sec.gov/rules/proposed/2013/33-9416.pdf (proposed amendments to Form D and certain notice and disclosure requirements).

[2]The term “accredited investor” is defined in Rule 501(a) of Regulation D to include any person who comes within certain enumerated categories of investors or whom the issuer “reasonably believes” to come within any of such categories at the time of sale of the securities to that person.  For a natural person to qualify as an accredited investor, he or she must (i) have an individual net worth, or joint net worth with his or her spouse, exceeding $1 million (excluding the value of the person’s primary residence), or (ii) have had individual income in excess of $200,000 (or joint income with his or her spouse of $300,000) in each of the two most recent years, and have a reasonable expectation of reaching the same income level in the current year.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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