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People Got to be Free (to Advertise): Proposed Rules to Permit Advertising in Rule 506 Offerings
David H. Oden, Christina W. Marshall
On August 29, 2012, the Securities and Exchange Commission released proposed rules to permit general advertising and solicitation in certain private placement offerings as required by the recently enacted JOBS Act. The proposed rules permit issuers to advertise in connection with Rule 506 private placement offerings so long as the securities are sold only to accredited investors.
Prior to these proposed rules, advertising and solicitation have not been permitted in connection with a Rule 506 private placement (or any other offering of securities). As noted by the SEC, in 2010 and 2011, issuers raised an estimated $895 billion and $902 billion, respectively, in Rule 506 offerings. Rule 506 is therefore an important vehicle through which issuers can raise capital.
The proposed rules would amend Rule 506 of Regulation D to provide that the prohibition against general advertising and solicitation set forth in Rule 502(c) of Regulation D will not apply to private placements of securities made pursuant to Rule 506, provided that all purchasers of securities are accredited investors and the issuer takes “reasonable steps to verify” that the purchasers are accredited investors. Additionally, the proposed rules require that the issuer designate that it utilized general advertising or solicitation when the issuer files its Form D with the SEC.
Eliminating the Prohibition against General Solicitation
The SEC proposed a bifurcated approach to Rule 506 offerings. Issuers who rely on Rule 506 to consummate a private placement may utilize general advertising and solicitation in the offering or not. If the issuer decides not to advertise or solicit in connection with the Rule 506 offering, the issuer may conduct such private placement in accordance with the terms and conditions of the old Rule 506. If the issuer publicly advertises or solicits in connection with such offering, it will have to conduct the offering in accordance with the new Rule 506(c), once adopted.
The proposed Rule 506(c) permits general solicitation and advertising in connection with a private placement of securities pursuant to Rule 506 subject to the following conditions:
- All purchasers of securities in the offering must be accredited investors, either because they fall within one of the enumerated categories of persons that qualify as accredited investors, or the issuer reasonably believes that they do, at the time of the sale of securities;
- The issuer must take reasonable steps to verify accredited investor status;
- All terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied; and
- The issuer must file a Form D disclosing that it utilized general solicitation and advertising.
The SEC noted that the ability to conduct a general solicitation in connection with a private placement of securities is available only for offerings under Rule 506(c) and not for Section 4(a)(2) private placements in general.
Reasonable Steps to Verify Accredited Investor Status
The JOBS Act mandates that the amendment to Rule 506 requires that issuers “take reasonable steps to verify that purchasers of the securities are accredited investors.” Historically, an issuer relying on Rule 506 could sell its securities to persons that it “reasonably believed” were accredited investors. Such belief could be based solely on the investor’s representation that the investor was accredited. Under the new Rule 506(c), a mere representation by an investor of investment status is not sufficient. If the issuer is utilizing general advertising and solicitation in connection with the offering, the issuer must take additional, reasonable steps to verify that the purchasers are accredited investors.
The SEC proposed a flexible approach to investor verification under Rule 506(c). Whether steps taken are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction. This standard reflects that “reasonable efforts” to verify investor status may differ depending on the facts and circumstances of a particular offering.
The SEC provided a non-exclusive list of factors that issuers may consider when determining the reasonableness of the steps to verify that a purchaser is an accredited investor:
- 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 a minimum investment amount.
The nature of the purchaser and the type of accredited investor that the purchaser claims to be are important factors because, as the SEC points out, the steps that may be reasonable to verify that an entity is an accredited investor by virtue of being a registered broker-dealer (for example) would necessarily differ from the steps that would be reasonable to verify whether a natural person is an accredited investor. For the former, it would likely be reasonable to verify such entity’s status on FINRA’s BrokerCheck website, but a different verification process would be needed for a natural person. There are eight enumerated categories of investors who qualify as accredited investors and the SEC recognizes that reasonable steps to verify the status of each would likely be very different.
The SEC points out that the amount and type of information that an issuer has about a purchaser would be significant factors in determining what additional steps would be reasonable to verify the purchaser’s accredited investor status. Basically, the more information an issuer has indicating that a purchaser is an accredited investor, the fewer additional steps the issuer must take to verify status, and vice versa.
The nature of the offering and the means by which solicitation occurs may be factors in the issuer’s determination of the reasonableness of the steps taken to verify accredited investor status. For example, if the offering is advertised generally to the entire population, the issuer may have to take significant additional steps to verify investor status. On the other hand, if the issuer solicits investors from a pre-screened pool of potential investors, then less verification may be needed.
The SEC suggests that an issuer’s reliance on a third-party verification of an investor’s status would be reasonable so long as the issuer has a reasonable basis to rely on such third-party verification. For example, the issuer may request that the purchaser’s legal counsel provide a written statement stating that such counsel examined the purchaser’s financial records and the purchaser meets one of the eight enumerated categories of investors who qualify as accredited investors. We expect this practice to gain wide-spread usage.
The proposed rules provide that a separate check box will be added to the current Form D for issuers to indicate whether they are claiming an exemption under the new Rule 506(c). The Form D must be filed within 15 days of the first sale of securities in the offering. Issuers will be required to check the box if they utilized general advertising and solicitation as permitted by Rule 506(c).
Proposed Amendment to Rule 144A
Prior to the proposed rules, Rule 144A restricted an issuer’s ability to offer securities to anyone other than qualified institutional buyers and prohibited advertising in connection with the offering. Under the proposed rules, the SEC’s revisions make it clear that the securities in a Rule 144A offering can be offered to anyone but can only be sold to qualified institutional buyers and the issuer can engage in general advertising and solicitation. Additionally, under the proposed rules, resales of securities pursuant to Rule 144A could be conducted using general solicitation so long as all purchasers are qualified institutional buyers.
As is common with rules proposed by the SEC, the general public is permitted and encouraged to review the proposed rules and provide comments to the SEC on or before October 5, 2012.
After many months of speculation and commentary regarding the JOBS Act’s mandate to permit general solicitation and advertising in connection with Rule 506 offerings, the SEC has proposed a reasonable set of rules that should not unduly burden issuers or purchasers. We are pleased with the bifurcated approach to Rule 506 because it allows issuers to conduct a Rule 506 offering with or without advertising. While we believe that many issuers will avail themselves of the new Rule 506(c), we recognize that there are many issuers who do not want to engage in general solicitation and advertising and those issuers can still utilize the Rule 506 exemption without the extra requirements of Rule 506(c).
If you have any questions about this topic, please contact a member of our Venture Capital/Emerging Company or Capital Markets and Securities practice groups.