SEC Proposes Amendments to Allow Advertising and General Solicitations in Private Placements and Rule 144A Offerings
Summary: The SEC has proposed to amend Securities Act Rule 506’s private placement safe harbor to add Rule 506(c). The proposed rule would permit a second class of offering, where general solicitations and advertisements would be allowed provided that all of the purchasers were accredited investors, as defined in Rule 501(a), that the issuer believes the purchasers are accredited investors and that the issuer has taken reasonable steps to verify that the purchasers are accredited, investors. The SEC also proposes to amend Form D that is filed in connection with a private placement under Regulation D to include a box to be checked if the offering was made in reliance on Rule 506(c). The SEC would also amend Rule 144A to allow general solicitations and advertisements if the seller reasonably believes that the purchasers are all qualified institutional investors.
Background: Regulation D Rule 506 presently offers a safe harbor to a private placement effected with an unlimited number of accredited investors and up to 35 non-accredited investors who have or have a representative who has sufficient knowledge and experience in financial and business matters that he/it is capable of evaluating the merits and risks of the offering subject to certain conditions. These conditions are: (a) no general solicitation or advertisement of the offering; (b) the offering is not “integrated” with offerings made in the prior 6 months or in the next 6 months; (c) in the case of sales to non-accredited investors, specified information is provided; (d) the sold securities are restricted securities, and the issuer takes reasonable steps to limit their resale and that investors are not statutory “underwriters”—bought with a view to re-sell; and (e) a Form D is filed with the SEC.
Rule 144A allows a third party to sell a company’s stock outside of the registration process if certain conditions are met, including that the seller or his representative reasonably believes that the purchaser is a qualified institutional buyer.
Solicitations in a Private Placement: The SEC has proposed adoption of a new Rule 506(c). This would allow general solicitations and advertising in connection with a private placement. However, certain conditions must be met. These are: (a) the issuer takes reasonable steps to verify that the purchasers are accredited investors; (b) all purchasers are accredited investors or the issuer reasonably believes they are; and (c) the rules regarding integration of offerings of the same or similar securities within 6 months before and after the subject offering and restrictions on re-sale apply.
Reasonable Steps to Verify Accredited Investor Status: The SEC’s proposal does not specify what constitutes reasonable steps to verify that an investor is an accredited investor. Instead, the proposal states that this is an objective determination based on the particular facts and circumstances of each transaction. It sets out three factors for consideration: (1) the nature of the purchaser and type of accredited investor he/it is; (2) the amount and type of information issuer has about the purchaser; and (3) the nature and terms of the offering and the manner in which the purchaser was solicited to participate in the offering.
Nature of the purchaser. The issuer must determine the basis on which the purchaser is an accredited investor. Depending upon which class of accredited investor the purchaser falls in, the SEC stated that it expects issuers to take different steps to verify that fact.
Information about the purchaser. The SEC proposal gives examples of information to review. This includes publicly available federal, state or local filings. Is the person a senior officer of a public company whose compensation is disclosed in an SEC filing made within the last three years? Is it a 501(c)(3) organization with $5 million in assets as disclosed in its IRS Form 990 return? If he/she is a natural person, the issuer should conduct a review of their Forms W-2. In the case of a person in an industry where publications show the average compensation of persons at the purchaser’s level in the workplace, reliance could be made on such publications. Or verification can be made by relying on a third party, e.g. a broker-dealer, attorney or accountant.
Nature and Terms of the Offering. In the case of an offering involving a general solicitation, advertising or made by means of a social media or internet website, the reliance on a check the box certification by a purchaser that he/she/it is an accredited investor is not sufficient according to the SEC proposal. On the other hand, it would be sufficient if the investor makes a substantial or minimum cash investment without the use of third party financing that only an accredited investor could be expected to make. Finally, the SEC stated that the issuer must document and retain the measures taken to verify that a purchaser was an accredited investor. The SEC proposal stated that the reasonable belief standard that a purchaser in a Rule 144A offering is a qualified institutional buyer is not being changed.
Form D. The SEC proposes to amend Form D that must be filed after a private placement under Regulation D is commenced to include a new box under Item 6 indicating that an offering was made under proposed Rule 506(c).
Offshore Offerings. In the proposal the SEC made clear that an offering to foreign investors under Regulation S would not be affected by a concurrent offering under Rule 506(c) and Rule 144A where there is general solicitation and advertising.
Private Investment Funds/Hedge Funds. The proposing release noted that companies relying on the exceptions from the definition of an investment company in Section 3(c)(1) [companies making a private offering to less than 100 purchasers] and Section 3(c)(7) [companies making a private offering to purchasers who are qualified purchasers] would not be affected if the offerings were made in reliance upon Rule 506(c).