I. Background and Overview
Section 201 of the Jumpstart Our Business Startups Act (the "JOBS Act") requires the SEC to amend Rule 506 and Rule 144A under the Securities Act to, in certain circumstances, eliminate the prohibition against general solicitation during the private placement of securities. In the case of those securities offerings that claim the Rule 506 exemption from the registration requirements of the Securities Act, once the SEC amends Rule 506, general solicitation and general advertising will be allowed so long as all purchasers of the securities are "accredited investors." Under the revisions to the Rule 144A exemption, general solicitation and general advertising will be allowed so long as the seller of the securities only sells the securities to those buyers whom the seller reasonably believes are "qualified institutional buyers."
The JOBS Act became effective on April 5, 2012, and the provisions of the statute required that the SEC revise Rules 506 and 144A within 90 days. However, the proposed rules were not published in the Federal Register until Sept. 5, 2012, and the comment period for such rules just closed on Oct. 5, 2012. Comments continue to be posted, and the SEC has not indicated when a final rule will be issued. Until the proposed rules are actually final, the current prohibition on general solicitation and advertising remains in effect.
However, an examination of the proposed rules is instructive. SEC Chairman Mary Schapiro stated that the proposed rules are only designed to "undertake this . . . narrow mandate that Congress has placed upon [the SEC] through the JOBS Act," and that the time "for [the SEC] to take a thorough look at the private placement market" was "in the future."
II. Proposed Changes to Rule 506
The current Rule 506 exempts an issuer from the costly SEC registration requirements if certain terms and conditions are met, and allows private placement of securities to an unlimited number of "accredited investors" and up to 35 non-accredited investors. One such condition of applicability for the current Rule 506 is that the issuer does not engage in "general solicitation or general advertising." The proposed revision to Rule 506 will allow issuers to engage in general solicitation or general advertising, so long as all applicable terms and conditions are met and "all actual purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors." The nonsolicitation provision will still apply if the issuer does not reasonably believe that all purchasers are accredited investors or if the issuer fails to take reasonable steps to determine accredited investor status.
The proposed revisions to Rule 506 require that issuers wishing to use general solicitation "take reasonable steps to verify" that all purchasers are accredited investors. The proposed rules do not delineate precise steps to be followed to ensure reasonableness, but instead provide that what is reasonable is "an objective determination, based on the particular facts and circumstances of each transaction." Relevant factors in determining the extent of the required verification steps include but are not limited to (1) the nature of the purchaser, (2) the amount of information that the issuer has about the purchaser, and (3) the nature of the securities offering. The SEC considered proposing specific methods of verification, but chose not to require any specific methods in the proposed rule, because of the wide range of characteristics of potential accredited investors and the resulting impracticability of a one-size-fits-all approach.
After it takes reasonable steps to verify accredited investor status, the issuer must have a "reasonable belief" that all purchasers are accredited investors. Selling securities to anyone that the issuer does not reasonably believe is an accredited investor makes the Rule 506 exemption inapplicable if general solicitation has occurred, thus requiring SEC registration if no other exemption applies. But, if the issuer reasonably believes that all purchasing persons or entities are accredited investors, the Rule 506 exemption will still apply even if it is discovered after the sale closes that the person or entity was not in fact an accredited investor.
III. Proposed Changes to Rule 144A
The current Rule 144A applies to, among other things, resales of securities that were acquired in a private placement. Such resales are exempt from the registration requirements if they are sold to "qualified institutional buyers" and meet certain other requirements. Under the current version of the rule, the exemption only applies if all offers are made to qualified institutional buyers. This provision creates an implicit prohibition on general solicitation and advertising, since such actions would necessarily involve making offers to persons or entities that were not qualified institutional buyers.
The proposed revision to Rule 144A would require only that sales of securities be made to qualified institutional buyers, thus allowing general solicitation and general advertising that may also reach those who are not qualified institutional buyers. So long as the seller reasonably believes that all buyers are qualified institutional buyers, the Rule 144A exemption to the registration requirements will still apply notwithstanding the fact that offers in the form of general solicitation or general advertisement may have been made to persons or entities that are not qualified institutional buyers.
For more information contact:
Henry Beck, Jr.
beck@halloransage.com