General Solicitation Permitted In Certain Rule 506 And Rule 144A Offerings; 'Bad Actors' Disqualified From Rule 506 Offerings; Other Significant Amendments Proposed To Regulation D

At its meeting on July 10, 2013, the Securities and Exchange Commission (SEC):

adopted amendments to Rules 506 and 144A under the Securities Act of 1933 (Securities Act) to eliminate the existing prohibition on general solicitation and general advertising (referred to throughout this alert as "general solicitation") in connection with private securities offerings made in accordance with the other requirements of each rule;1 adopted further amendments to Rule 506 to make the exemption in Rule 506 unavailable to issuers if one or more of the issuer and certain related persons have been the subject of certain felony or misdemeanor convictions or other disqualifying events and to require disclosure regarding bad actors in certain instances;2and proposed additional amendments to Regulation D that would require disclosure of additional information about Rule 506 offerings made by general solicitation in order to "enable the SEC to monitor the market with [the general solicitation] ban now lifted."3 The amendments to Rule 506 and Rule 144A to eliminate the prohibition on general solicitation in certain offerings were adopted to implement the requirements of Section 201(a) of the Jumpstart Our Business Startups Act (JOBS Act).4The amendments to Rule 506 relating to the disqualification of bad actors implement the requirements of Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed amendments to Regulation D, if ultimately adopted, would impose additional safeguards for private offerings involving general solicitation.

The amendments adopted on July 10, 2013, will be effective 60 days after the date on which the related adopting release is published in the Federal Register.

This client alert discusses key aspects of the amendments and the proposed amendments and provides practical considerations for issuers to consider.

Amendments to Rule 506 and Rule 144A to Eliminate the Prohibition on General Solicitation in Certain Private Offerings

The Amendments to Rule 506

Background. Section 4(a)(2) of the Securities Act (Section 4(2) prior to enactment of the JOBS Act) exempts from the registration requirements of Section 5 of the Securities Act an issuer's offers and sales of securities "not involving any public offering." As the Supreme Court stated in its first decision interpreting this language, "[t]he Securities Act nowhere defines the scope of [Section 4(a)(2)]'s private offering exemption. Nor is the legislative history of much help in staking out its boundaries."5 With legislative guidance absent, both the courts and the SEC have long and consistently viewed general solicitation in an offering, whether by public advertising or use of the facilities of a securities exchange, as incompatible with the concept of a non-public offering.6

As the SEC has adopted rules under Section 4(a)(2) to provide issuers with non-exclusive safe harbors for non-public offerings, first in the now rescinded Rule 146 (which should not be confused with the current Rule 146 under the Securities Act) and then with the successor rules in Regulation D (including Rule 506), it has allowed issuers to offer and sell an unlimited amount of securities to an unlimited number of "accredited investors" (as defined in Securities Rule 501(a)), and to no more than 35 non-accredited investors that satisfy certain sophistication requirements if certain conditions were satisfied. The SEC incorporated its historical prohibition on general solicitation as one of the conditions to the availability of the safe harbor, i.e., no offer or sale of securities could be made by any form of general solicitation, such as advertisements published in newspapers and magazines, communications broadcast over television and radio, seminars whose attendees have been invited by general solicitation and other uses of publicly available media, including unrestricted websites.

The JOBS Act directed the SEC to reverse its almost 75 year-long position that general solicitations are incompatible with the notion of non-public offerings.7 Specifically, the JOBS Act required the SEC to amend Rule 506 to permit general solicitation in offers and sales made under the rule if all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that purchasers of the securities are accredited investors, using methods to be determined by the SEC. This dramatic change to private offering practice and interpretation is limited: Congress did not amend Section 4(a)(2) itself; the direction of the JOBS Act only required the SEC to eliminate the general solicitation ban with respect to certain offerings satisfying the conditions set out in Section 506. In view of Section 4(a)(2) retaining its original language, the SEC said in the 506(c) Adopting Release that general solicitation is still inconsistent with offerings being exempt pursuant to Section 4(a)(2) or other Regulation D safe harbors that specifically prohibit general solicitation in an offering.8

The Amendments. The SEC adopted new paragraph (c) to Rule 506 (Rule 506(c)), which will permit the use of general solicitation in unregistered offers and sales of securities by the issuer if:

all purchasers of the securities are accredited investors; the issuer takes "reasonable steps" to verify that the purchasers are accredited investors; and all the terms and conditions of Securities Act Rules 501, 502(a) and 502(d) are satisfied.9 In response to commentators' concerns, the SEC confirmed in the 506(c) Adopting Release that the "reasonable belief" standard found in the existing "accredited investor" definition in Rule 501 remains in place. Thus, if an issuer takes reasonable steps to verify that each purchaser is an accredited investor and, having taken those steps to verify the status of each purchaser, has a reasonable belief the purchaser is an accredited investor, the issuer will not lose the ability to rely on Rule 506(c) if it is discovered subsequently that a purchaser in the offering was not an accredited investor.

Issuers intending to rely on Rule 506(c) to offer securities should note that, even if they know the proposed purchasers in an offering are accredited investors or even if all purchasers are in fact accredited investors, they must still take reasonable steps to verify the status of each purchaser in the offering to comply with the requirements of Rule 506(c). This principle applies even in circumstances in which the status of a purchaser as an accredited investor is readily apparent from the circumstances of an offering, such as when an offering has a high minimum investment, because this is an independent procedural requirement and the issuer must still take reasonable steps to verify the conclusion it draws from those circumstances if the exemption of Rule 506(c) is to be available for the offering.

While general solicitation will be permitted under the circumstances set forth in Rule 506(c), the SEC has not adopted rules governing the content and manner of solicitations and advertising used in such offerings despite suggestions from commentators that it adopt such rules, particularly with respect to offerings by private funds. However, the SEC notes that it will monitor private fund advertising and undertake a review to determine if further action is necessary.10 As discussed below, the SEC has proposed a further amendment to Regulation D to require all issuers to submit any written communication that constitutes general solicitation to the SEC no later than the date of the communication's first use.

The SEC has retained, without amendment, Rule 506(b), which gives issuers the ability to conduct Rule 506 offerings without the use of general solicitation (often referred to as "quiet offerings"). Thus, issuers may continue to utilize existing Rule 506(b) when raising capital, which may be important for those issuers not needing to make a general solicitation to conduct a successful offering and that want to avoid the burden of meeting the reasonable verification steps requirement of Rule 506(c), that want to sell securities to non-accredited investors meeting the rule's sophistication requirements or that want to have Section 4(a)(2) as a possible fallback in the event the issuer cannot rely on the safe harbor provided by Rule 506(b). However, as we discuss below, if the issuer inadvertently engages in general solicitation in an attempted Rule 506(b) offering, the exemption of Section 4(a)(2) would not be available for the offering. The amendments to Rule 506 do not affect Rule 504 or 505.

Importantly, Section 201(a) of the JOBS Act provided that Section "230.506 of title 17, Code of Federal Regulations, as revised pursuant to this section, shall continue to be treated as a regulation issued under section 4(2) of the Securities Act of 1933 ... ." Moreover, Section 201(b) of the JOBS Act added a new Section 4(b) to the Securities Act, which provides that offers "and sales exempt under section 230.506 of title 17, Code of Federal Regulations (as revised pursuant to section 201 of the Jumpstart Our Business Startups Act) shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.'' The combination of these two statutory provisions has two important implications. First, securities issued in connection with a Rule 506(c) offering will be restricted securities under Rule 144. Second, the securities issued in such an offering will have the status of securities issued under Section 4(a)(2), qualifying them as "covered securities" under Section 18(b)(4)(E) of the Securities Act for purposes of the state "blue sky" law preemption provision of Section 18 of the Securities Act.

The "Reasonable Steps to Verify" Requirement. Rule 506(c) in its final form does not impose exclusive measures for the verification of the accredited investor status of purchasers. Commentators have been...