July 22, 2013
The Securities Exchange Commission has adopted final rules to remove the prohibition on general advertising and solicitation in securities offerings conducted in accordance with Rule 506 of Regulation D or Rule 144A under the Securities Act of 1933. When the rules become effective 60 days after publication in the Federal Register, new Rule 506(c) will permit general solicitation and advertising in connection with such offerings so long as the issuer takes “reasonable steps to verify” that the purchases are made by accredited investors.
Oddly, the most controversial part of the new rules isn’t even binding. The final rules − which otherwise predictably follow the proposed rules (see our September 2012 alert here) − include a list of non-exclusive, non-mandatory safe harbor standards concerning the types of evidence that an issuer can review that would constitute “reasonable steps to verify” accredited investor status under Rule 506(c).
At least part of the investment community has already reacted negatively to the safe harbors, fearing that they will become the de facto standard for verification of accredited investor status under Rule 506(c). They contrast this with the long-standing practice of investor self certification, pursuant to which, most practitioners agree, the issuer may form a reasonable belief of accredited investor status for purposes of Rule 506(b). The Angel Capital Association (ACA) stated in a press release:
Final rules ending the ban on general solicitation for companies seeking investment from accredited investors eliminates the ability of angels to self‐certify their status, and will result in many angels refusing to participate in this type of investing.
“With thousands fewer angels participating in this market, startups will have far less access to capital, the millions of jobs they create each year will disappear, and the economy will suffer,” said Marianne Hudson, executive director of ACA. “This is the exact opposite of Congress’ intent in its near‐unanimous passage of the JOBS Act.”
“Angel investors provide the fundamental source of start‐up capital in our economy,” Hudson said. “Not a single angel I have spoken with is willing to provide personal financial information to an issuer who is asking them for investment. This violation of privacy is untenable, especially for the angels who do multiple deals a year.”
A major problem with Rule 506(c) is that failure to take reasonable steps to verify accredited investor status might result in an unregistered public offering, the remedy for which would at a minimum involve rescission. Fear of this outcome could actually discourage issuers from making a general solicitation in reliance on Rule 506(c).
Also problematic is whether the use of the Rule 506(c) verification standard will be interpreted to impose an equivalent verification standard upon the “reasonable belief” standard − including self-certification − that has prevailed for many years under Rule 506(b). The SEC has offered some comfort on this issue, though we should not assume that courts will agree if faced with a messy set of facts. In its Fact Sheet on the meeting of the Commission at which the final rules were adopted, the SEC said:
The existing provisions of Rule 506 as a separate exemption are not affected by the final rule. Issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren’t subject to the new verification rule.
It’s worth remembering that Rule 506(b) offerings may include up to 35 non-accredited purchasers (if certain information delivery requirements are met), perhaps resulting in a strong enough distinction between Rules 506(b) and 506(c) to provide a basis for maintaining the differences in the nature of the determination of “accredited” status.
Under the final rule, securities sold pursuant to Rule 144A can be offered to persons other than qualified institutional buyers, or QIBs, including by means of general solicitation, provided that the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe to be QIBs.
The final rule amends Form D, which is the notice that issuers must file with the SEC when they sell securities under Regulation D. The revised form adds a separate box for issuers to check if they are claiming the new Rule 506(c) exemption that would permit general solicitation or general advertising.