Sunday, September 9, 2012

The SEC Issues Proposed Rules to Eliminate the Prohibition Against General Solicitation in Rule 506 Offerings

On August 29, 2012, the Securities and Exchange Commission (the SEC) issued proposed amendments to Rule 506 of Regulation D and Rule 144A to implement Section 201(a) of the JOBS Act.  The SEC is soliciting comments on the proposed rules.  The comment period ends on September 28th

In its release, the SEC acknowledged that it received numerous other suggestions on how to revise Rule 506, the definition of the accredited investor, and the Form D.  However, currently the SEC is only concerned with amendments required by the JOBS Act.  In particular, the SEC proposed new Rule 506(c), which would permit the use of general solicitation in Rule 506 offerings provided that (1) the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors and (2) all purchasers of securities must be accredited either because they satisfy the accredited investor definition or the issuer reasonably believes that they do, at the time of the sale of the securities. 

The new Rule’s main uncertainty comes from the requirement that the issuer must take “reasonable steps” to verify that the purchasers are accredited investors. 

Instead of a bright-line test, a specified list or a methodology that would provide issuers with greater certainty that they have satisfied the “reasonable steps” requirement, the SEC decided not to require issuers to follow uniform verification methods.  Instead, the SEC suggested a number of factors that issuers should take into consideration.  Whether the factors are “reasonable” becomes an objective determination based on particular facts and circumstances of each transaction.  Examples of the factors include: (1) nature of the purchaser; (2) information that the issuer has about the purchaser; and (3) nature and terms of the offering. 
With respect to the first factor (the nature of purchaser), the SEC noted that reasonable steps would be different depending on which of the eight categories of the accredited investor definition the investor satisfies.  Checking that the investor is a broker-dealer is easy (through the FINRA website), whereas checking that a natural person has over $1 million in assets may be much more difficult due to privacy concerns.  Perhaps, a way to go here is to ask for a letter from the investor’s accountant verifying the accredited status of the individual.

With respect to second factor (the information that the issuer has about the purchaser), the SEC provided examples such as Form W-2s, public company filings, and third-party information.  This factor puts a burden on the issuer to seek such information and it is unclear how much and what kind of information would be sufficient. 

Finally, with respect to third factor (the nature and terms of the offering), the SEC noted that a high minimum investment could be a relevant factor, as well as whether the issuer is soliciting investors through a generally accessible website or a social media platform as opposed to a re-screened accredited investors database maintained by a broker-dealer. 

In conclusion, the burden is on the issuer claiming the exemption that it is entitled to that exemption.  And due to the uncertainty as to the exact nature of reasonable steps the issuer must take to verify the accredited investor status of its investors, this burden may be heavy enough to deter some issuers from resorting to the new Rule 506(c) when conducting private placements. 

I look forward to reading the final rules.  

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

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