On July 10, 2013, the Securities and Exchange Commission (“SEC”) adopted a new rule to implement a JOBS Act requirement to lift the ban on general solicitation and general advertising for offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) and allowing general solicitation in connection with securities offerings conducted under SEC Rule 144A.
The SEC also approved final rules disqualifying securities offerings from relying on Rule 506 if they involve certain felons or other “bad actors”. In addition to the final rules, the SEC proposed rules requiring issuers making offerings under amended Rule 506 to provide certain information to enable the SEC to monitor Rule 506 offerings involving general solicitation.
According to the SEC, the proposals provide for additional safeguards as the market changes and new practices develop. Mary Jo White, Chair of the SEC stated, “As we fulfill our mission to facilitate capital formation and maintain fair and efficient markets, the Commission must always focus on strong investor protections …We want this new market and the private markets in general to thrive in a safe and efficient manner, and these rules we adopt and propose are designed to facilitate that objective.”
The Final Rules l Rule 506 Public Placements
The SEC’s final rules were mandated by Section 201(a) of the Jumpstart Our Business Startups Act.
The amendments to Rule 506 eliminate the prohibition against general solicitation for the offer and sale of securities conducted under Rule 506 of Regulation D of the Securities Act and Rule 144A under the Securities Act, as long as all investors are accredited investors or qualified institutional buyers. The SEC was over a year past the date by which it was mandated by Congress to adopt the final rules amending Rule 506.
Effectiveness of Amendments to Rule 506
The amendments to Rule 506 will become effective 60 days after publication in the Federal Register. The rule proposal will undergo a 60-day public comment period following its publication in the Federal Register.
About the Rule 506 Exemption
Companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from the registration statement requirements. Most exemptions from registration prohibit companies from engaging in general solicitation or general advertising and require that issuers have a pre-existing relationship with investors prior to offering or selling securities to them. Rule 506 of Regulation D is the most widely-used exemption from registration. In Rule 506 offering, an issuer may raise an unlimited amount of capital from an unlimited number of “accredited investors” and up to 35 non-accredited investors.
Accredited Investor Definition l Rule 506 Offerings l JOBS Act
Under Rule 501, a person qualifies as an accredited investor if he or she has either:
♦ An individual net worth or joint net worth with a spouse that exceeds $1 million at the time of the purchase, excluding the value (and any related indebtedness) of a primary residence; or
♦ An individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
Solicitation in Rule 506 Public Placements
Issuers conducting Rule 506 offerings are able to widely solicit and advertise for potential investors, the SEC points out that the issuer is required “to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” In other words, there is no restriction on who an issuer can solicit, but there are significant restrictions on who may purchase the issuer’s securities in a Rule 506 offering.
The final changes allow issuers to use general solicitation and general advertising to offer their securities provided that:
♦ The issuer takes reasonable steps to verify that the investors are accredited investors; or
♦ All purchasers of the securities fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
Rule 506 of Regulation D l Verification of Accredited Investor Status
IRS Tax Forms and Publications
The determination of the reasonableness of the steps taken to verify an accredited investor for purposes of Rule 506 is an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each investor and the transaction. The SEC’s final rule provides a non-exclusive list of methods that issuers may use to satisfy the verification requirement of Rule 506 for individual investors.
The methods to confirm accredited investor status include but are not limited to the following:
♦ Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
♦ Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
Form D for Rule 506 Offerings l Checking the General Solicitation Box
The final rule amends Form D filings for Rule 506 offerings. The revised Form D adds a separate box for issuers to check if they are claiming the new Rule 506 exemption that would permit general solicitation or general advertising.
The existing provisions of Rule 506 as a separate exemption are not affected by the final rule. Issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren’t subject to the new verification rule.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855