The SEC’s July 10th meeting has fundamentally changed the world of private placements by eliminating the blanket prohibition against general solicitation and general advertising in Rule 506 offerings. The SEC has adopted the rules it proposed almost a year ago (in August 2012) to implement Section 201(a) of the JOBS Act. Under amended Rule 506, a company will essentially have a choice of using Rule 506(b) to conduct a private placement subject to the current prohibition against general solicitation and general advertising or using new Rule 506(c), pursuant to which securities can be offered through general solicitation and general advertising. This may not be an easy or straightforward choice for a company contemplating a private placement.
New Rule 506(c), which will be effective 60 days after publication in the Federal Register, permits a company to offer securities using general solicitation and general advertising, only if it meets all of the following conditions:
- sales must satisfy all the terms and conditions of Rules 501 (Definitions and Terms Used in Regulation D) and 502(a) and (d) (Integration and Limitations on Resales);
- all purchasers of securities are accredited investors; and
- the company takes reasonable steps to verify that purchasers of its securities are in fact accredited investors.
Some companies may choose not to use Rule 506(c) because the determination of whether the steps taken are “reasonable” is based on a facts and circumstances analysis conducted by the company. A company conducting a private placement under current Rule 506(b) does not need to engage in the verification process described below and can rely on its reasonable belief that the purchaser satisfies one or more accredited investor criteria set forth in Rule 501(a). In addition, companies may decide not to use the new Rule 506(c), not only to avoid such verification process, but also in order to make private placements to non-accredited investors who meet the sophistication requirements of Rule 506(b).
For ongoing Rule 506 offerings that commence before the effective date of Rule 506(c), a company may choose to continue the offering after the effective date under either Rule 506(b) or Rule 506(c). If a company chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date, as permitted under such rule, will not affect the exempt status of offers and sales of securities that occurred under Rule 506(b) prior to the effective date.
A significant part of the SEC’s adopting release is focused on the analysis that a company must conduct to verify that a purchaser of securities in a Rule 506(c) offering is an accredited investor. The SEC has specifically stated in the adopting release that a company will not be deemed to have taken reasonable steps to verify accredited investor status if it only required an investor to check a box in a questionnaire or sign a form (which is an acceptable practice now under the current “reasonable belief standard” applicable to offerings under Rule 506(b)), in the absence of other information indicating accredited investor status of the purchaser. The SEC has embraced a principles-based method of verification and believes that a company should consider the following factors in its analysis:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the company has about the purchaser; and
- the nature of the offering (e.g., 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).
These factors are interconnected and the SEC stated that “[a]fter consideration of the facts and circumstances of the purchaser and the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify the accredited investor status.” To illustrate this, the SEC produced the following example: “if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party.”
A company may rely on a third party that has verified a person’s status as an accredited investor (assuming the company has a reasonable basis to rely on such third-party verification) or on publicly available information in filings with a federal, state or local regulatory body (e.g., proxy statement disclosing the compensation of a purchaser who is a named executive officer of a public company or IRS Form 990 disclosing total assets of a Section 501(c)(3) organization with $5 million in assets).
The means used by the company to solicit purchasers may be relevant in determining the reasonableness of the steps that a company should take to verify accredited investor status. The SEC has pointed out that “[a]n issuer that solicits new investors through a website accessible to the general public, through a widely disseminated email or social media solicitation, or through a newspaper, will 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 reasonably reliable third party.”
Recognizing the difficulty of determining what steps would be reasonable to verify an accredited investor’s status of a natural person and in response to comments, the SEC has provided the following examples of non-exclusive and non-mandatory methods that a company may use to verify that a natural person purchasing its securities in a Rule 506(c) offering is an accredited investor (assuming that the company does not have knowledge that such person is not an accredited investor):
- reviewing any IRS form that reports the purchaser’s (or with the purchaser’s spouse in the case of a person who qualifies as an accredited investor based on joint income with that person’s spouse) income for the two most recent years (including, but not limited to, Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040) and obtaining a written representation from the purchaser (or with the spouse) that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year;
- reviewing one or more of the following types of documentation dated within the prior three months and obtaining a written representation from the purchaser (or with the purchaser’s spouse in the case of a person who qualifies as an accredited investor based on joint net worth with that person’s spouse) that all liabilities necessary to make a determination of net worth have been disclosed:
- with respect to assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and
- with respect to liabilities: a consumer report from at least one of the nationwide consumer reporting agencies; or
- obtaining a written confirmation from one of the following persons or entities that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor:
- a registered broker-dealer;
- an investment adviser registered with the SEC;
- a licensed attorney who is in good standing under the laws of the jurisdictions in which he or she is admitted to practice law; or
- a certified public accountant who is duly registered and in good standing under the laws of the place of his or her residence or principal office.
- in regard to any person who purchased securities in a Rule 506(b) offering as an accredited investor prior to the effective date of 506(c) and continues to hold such securities, for the same issuer’s Rule 506(c) offering, obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.
Given the facts and circumstances analysis that a company has to perform in order to determine whether the purchaser of its securities in a Rule 506(c) offering is an accredited investor, on the one hand, and the privacy concerns of individual investors, on the other hand, it’s unclear whether general solicitation and general advertising in Rule 506 private placements will become a mainstream trend.