In an open meeting last Wednesday the Securities and Exchange Commission voted to propose rules and amendments to implement Section 201(a) of the JOBS Act, which is responsible for eliminating the prohibition on general solicitation and general advertising in private offerings conducted pursuant to Rule 506 of Regulation D and private resales conducted pursuant to Rule 144A of the Securities Act of 1933; provided that, in the case of Rule 506, all purchasers are accredited investors and reasonable steps have been take to verify their status as such, and, in the case of Rule 144A, all purchasers are qualified institutional buyers.
In 2011 issuer’s raised an estimated $895 billion in offerings using Rule 506 and an estimated $168 billion in offerings using Rule 144A. In 2010 those numbers were even higher, with an estimated $902 billion raised in offerings using Rule 506 and an estimated $233 billion raised in offerings using Rule 144A. In reality the Rule 506 numbers may be higher still, as even the Commission acknowledges that not everyone who uses the exemption files a Form D (which is a requirement, but not a condition to the availability, of the exemption).
Offers and Sales that Involve General Solicitation and General Advertising Under Rule 506
Under the proposed rules and amendments a new subsection (c) would be added to Rule 506 which would permit general solicitation and general advertising in offers and sales of securities provided that:
- the issuer of the securities–whether a company or a private investment fund, such as a hedge fund, venture capital fund or private equity fund–takes “reasonable steps to verify” that the purchasers are accredited investors;
- all of the purchasers are accredited investors because at the time of the sale of the securities they either came within the definition of an accredited investor, as set forth in Rule 501(a) of Regulation D, or the issuer reasonably believed that they came within the definition; and
- all of the terms and conditions of Rules 501 (Definitions), 502(a) (Integration) and 502(d) (Limitations on resale) of Regulation D are met.
Note: offers and sales of securities made pursuant new Rule 506(c) would not be subject to the information disclosure requirements of Rule 502(b), because all of the purchasers in such an offering would be accredited investors.
Reasonable Steps to Verify Accredited Investor Status
In an effort to provide flexibility to accommodate the various types of issuers, investors and methods of verification, the Commission declined to define what constitutes taking “reasonable steps to verify” that a purchaser is an accredited investor. Instead the proposing release indicates that reasonableness should be an objective determination, based on the facts and circumstances surrounding a given transaction. The proposing release also goes on to discuss in some detail three factors that an issuer might consider, among others, when assessing the reasonable likelihood that a purchaser is an accredited investor and the reasonable steps that would be necessary to verify a purchaser’s status as such.
The Nature of the Purchaser
The first factor to consider is the nature of the purchaser and the type of accredited investor that the purchaser claims to be. For example, verifying that a broker-dealer is an accredited investor by virtue of being registered under Section 15 of the Securities Exchange Act of 1934, can be accomplished by simply conducting a FINRA BrokerCheck search. Whereas verifying that an individual purchaser is an accredited investor under the annual income or net worth standards may require several steps and raise additional issues, such as privacy concerns regarding the type of personal financial information that a purchaser may need to provide to verify their status as an accredited investor.
Information About the Purchaser
The second factor to consider is the amount and type of information that an issuer has about a purchaser. For example, certain verifying information may already be in the public domain, such as information about a purchaser’s annual income garnered from a proxy statement or information found in a Form 990 about a non-profit organization’s total assets. Other third-party information that is not available publicly may also provide reasonably reliable evidence of a purchaser’s accredited investor status, such as copies of an individual’s Forms W-2 or 1099 to verify annual income. Additionally, a purchaser’s status as an accredited investor might be verified by a third-party service provider, such as a broker-dealer, attorney, accountant or other reasonably reliable third-party that offers verification services.
The Nature and the Terms of the Offering
The third factor to consider is really twofold: the nature of the offering and the terms of the offering. For example, the manner in which a purchaser is solicited, such as through a website accessible to the general public, a widely disseminated email or by social media, as compared to from a database of pre-screened accredited investors maintained by a reasonably reliable third-party, will require a greater or lesser number of steps to verify that the purchaser is an accredited investor. Likewise, the terms of the offering itself may bear on the number of steps required to verify that a purchaser is an accredited investor. For example, in the release the Commission notes that it tends to agree with the view that a purchaser’s ability to meet a high minimum investment amount could be relevant to an issuer’s evaluation of the steps necessary to verify the purchaser’s status as an accredited investor.
A Note on the Importance of Adequate Record Keeping
The proposing release also stresses the importance of an issuer retaining adequate records that document the steps taken to verify a purchaser’s status as an accredited investor because, in the event that a question should ever arise, the burden of demonstrating entitlement to an exemption from registration falls entirely on the issuer.
Offers and Sales that Do Not Involve General Solicitation and General Advertising Under Rule 506
In its current form, Rule 506 permits offers and sales of securities to an unlimited number of accredited investors and up to 35 sophisticated non-accredited investors, provided that when non-accredited investors participate in an offering the information disclosure requirements of Rule 502(b) are met. As proposed the rules and amendments would preserve Rule 506 in its existing form in amended subsection (b), maintaining the rule’s availability for those issuers who do not wish to engage in general solicitation and general advertising, and thus avoid becoming subject to the requirement that they take reasonable steps to verify purchasers’ accredited investor status, as well as those issuers who would like the option to include sophisticated non-accredited investors in their offerings.
General Solicitation and General Advertising Under Rule 144A
Under the proposed rules and amendments Rule 144A of the Securities Act would also be revised to permit offers of securities to persons other than qualified institutional buyers (QIBS), including by means of general solicitation and general advertising, provided that the securities are sold only to persons that the seller, or anyone acting on the seller’s behalf, reasonably believe to be a QIB.
Proposed Changes to Form D
Finally, the Commission is also proposing to revise Form D to add a separate box to be checked when an issuer uses general solicitation or general advertising in a Rule 506(c) offering. Such information would allow the Commission to get a general sense of the size of the market for offerings that use general solicitation and general advertising.
The Commission is soliciting comments on a number of aspects of the proposed rules and amendments, most notably on a variety of issues related to verification of accredited investor status. Comments are due 30 days from publication of the proposed rules and amendments in the Federal Register.