On August 29, 2012, the Securities and Exchange Commission (the SEC) proposed rules to eliminate the prohibition against general solicitation and general advertising in certain securities offerings. As mandated by the Jumpstart Our Business Startups Act (the JOBS Act), the rules (as proposed) would allow issuers to utilize general solicitation and general advertising in the offer of their securities under Rule 506 of Regulation D (Rule 506), provided that all purchasers of the securities are accredited investors. The proposed rules were subject to a 30-day comment period, after which the SEC will either adopt the rules as proposed or will do so with certain amendments. The comment period has expired, but as of the date of this publication, the SEC has not yet adopted final rules.
Section 201(a)(1) of the JOBS Act, the purpose of which was to promote and facilitate the capital funding of small businesses and was signed into law by President Obama on April 5, 2012, instructed the SEC to remove the general solicitation and general advertising prohibitions in connection with Rule 506 offerings. This change would permit issuers to notify the public of their intention to sell securities for capital raising purposes. The general solicitation and general advertising rules were, however, only to be relaxed as they apply to the sale of securities to accredited investors because the JOBS Act requires issuers to "take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission."
[T]he proposed rules fulfil Congress's clear directive that issuers be given the ability to communicate freely to attract capital, while obligating them to take steps to ensure that this ability is not used to sell securities to those who are not qualified to participate in such offerings - former SEC Chairman Mary Schapiro.
" [The proposed Rule,] when adopted, will authorize general solicitation in the offer and sale of securities"
The SEC proposed new Rule 506(c) that, when adopted, will authorize general solicitation in the offer and sale of securities subject to the following conditions:
the issuer must take reasonable steps to verify that purchasers are accredited investors; all purchasers must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities; and all terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied.
It is important to note that the proposed rules do not affect the existing safe harbor under Rule 506(b), which allows issuers to privately sell securities, without the use of general solicitation, to an unlimited number of accredited investors and up to 35 unaccredited investors. The SEC noted in the proposed rules that the Rule 506(b) safe harbor would be preserved because it:
represent[s] an important source of capital for issuers of all sizes ... that either do not wish to engage in general solicitation in their Rule 506 offerings (and become subject to the new requirement to take reasonable steps to verify the accredited investor status of purchasers) or wish to sell privately to non-accredited investors who meet Rule 506(b)'s sophistication requirements.
The JOBS Act did not specifically dictate how issuers should satisfy the requirement that they take "reasonable steps" to verify purchasers' accredited investor status and therefore left that determination to the SEC. The proposed rules provide that the determination of whether an issuer took reasonable steps would be an objective one, determined on a case-bycase basis, based on factors such as:
1. "the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
2. the amount and type of information that the issuer has about the purchaser; and
3. the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount."
As for the first factor, the proposed rules provide that the steps reasonably taken by an issuer confirming the accredited status of a purchaser who claimed to be accredited because it was a registered broker-dealer, for example, would naturally be quite different from the steps reasonably taken by an issuer confirming the accredited status of a natural person. The latter process, the proposed rules indicated, would be more onerous.
Discussing the second factor, the proposed rules provide that issuers with ample information about potential purchasers would have less of a burden in establishing accredited investor status than issuers with little or no prior knowledge of potential purchasers. The proposed rules provide that issuers selling to natural persons claiming to be accredited investors would be wise to look toward publically available information about the purchaser, as well as information provided directly by the purchaser such as a W-2, assuming the purchaser is willing to divulge such personal information.
On the third factor, the nature of the offering, the proposed rules provide that the means used by the issuer to contact potential purchasers and inform them of the securities offering would be relevant in establishing the extent of the steps necessary to reasonably verify accredited investor status:
An issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reliable third party, such as a registered broker dealer.
In the example of the social media or website advertisement of an offering, the proposed release affirmatively states that relying on a simple check-the-box accredited investor questionnaire would not constitute reasonable steps to verify accredited investor status. The proposed rules also indicate the size of the minimum investment, provided such investments are made in cash and not financed, is also considered relevant, on the theory that an investor's ability to invest a sufficiently large sum tends to indicate accredited investor status.
As with most tests based on a series of factors, the reasonable steps inquiry will likely be one based on the particular facts and circumstances. The SEC specifically declined to take a position urged by many commentators that would have imposed more rigid and specific guidelines to be used in determining accredited investor status, opting to be used in determining accredited investor status, opting instead to maintain flexibility in the process. The proposed rules even indicate that the flexible approach saves the way for "changing market practices, and [the implementation of] innovative approaches to meeting the verification requirement, such as the development of third-party databases of accredited investors."
Once the final rules are implemented, it remains to be seen whether the lack of specific guidelines will inhibit issuers from utilizing the new general solicitation rules, or whether market practices will develop that provide comfort to issuers who choose to take advantage of the new rules.
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