On July 10, the Securities and Exchange Commission adopted certain new rules and proposed others applicable to certain securities offerings that are exempt from registration under the Securities Act of 1933 (Securities Act).  The SEC voted to adopt final rules (i) lifting the decades-old ban on general solicitation and general advertising in connection with private securities offerings conducted in reliance upon the exemptions from registration provided by Rule 506 of Regulation D under the Securities Act and Rule 144A under the Securities Act (Final General Solicitation Rules), and (ii) disqualifying issuers from relying on Rule 506 for securities offerings involving certain felons and other so-called “bad actors” (Final Bad Actor Rule). The SEC also proposed several new rules related to private securities offerings, including rules that would impact Form D filings and written general solicitation materials (Proposed Rules). 

Final General Solicitation Rules

Section 201(a) of the Jumpstart Our Business Startups Act (JOBS Act) required the SEC to adopt rules eliminating the ban on general solicitation and general advertising (which, while not defined by the SEC, include advertisements in newspapers, communications broadcast over television, radio or unrestricted websites and seminars whose attendees have been invited by one of the foregoing means) in connection with offers and sales of securities made in reliance upon Rule 506. In accordance with that directive, the Final General Solicitation Rules add a new paragraph (c) to Rule 506 to permit an issuer or placement agents acting on behalf of the issuer to engage in general solicitation or general advertising in securities offerings conducted in reliance upon Rule 506; provided that all purchasers of the securities are accredited investors and the issuer takes “reasonable steps to verify” that such purchasers are accredited investors. The SEC’s adopting release provides that the determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by the issuer, and the release provides guidance regarding principles to be considered when analyzing whether an issuer has taken “reasonable steps to verify” accredited investor status. Moreover, in contrast to the SEC’s proposed rules to lift the ban on general solicitation (which were described in the September 7, 2012 edition of Corporate and Financial Weekly Digest), the final rules adopted by the SEC include a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons.[1] The Final General Solicitation Rules did not modify the requirements of Rules 501, 502(a) and 502(d), which remain applicable to Rule 506 offerings.

The SEC also adopted amendments to Rule 144A under the Securities Act that similarly will permit general solicitation and general advertising in Rule 144A offerings. Although Rule 144A does not expressly prohibit general solicitation, sellers (such as initial purchasers and other intermediaries) relying on Rule 144A, as currently in effect, are only permitted to offer securities to qualified institutional buyers (QIBs), which yields the same result.  In accordance with Section 201(a)(2) of the JOBS Act, the Final General Solicitation Rules amended Rule 144A(d)(1) to eliminate references to “offer” and “offeree,” thereby permitting sellers and intermediaries in Rule 144A offerings to offer securities to persons other than QIBs (including by means of general solicitation). Rule 144A continues to require, however, that securities are only sold to purchasers that are QIBs or that the seller and any intermediary or person acting on behalf of the seller reasonably believe are QIBs.

Final Bad Actor Rule

Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to adopt rules that disqualify issuers from relying on Rule 506 for securities offerings involving certain felons and other so-called “bad actors”.  

Subject to a reasonable care exception where the issuer can show that it did not, or could not, know that a covered person with a disqualifying event participated in the offering, the Final Bad Actor Rule will disqualify an issuer from relying on Rule 506 if the issuer, its predecessors, affiliated issuers, directors, executive officers, other officers participating in the offering, general partners and managing members, beneficial owners of 20 percent or more of the voting power of the issuer’s voting securities, promoters, investment managers or principals (in the case of a pooled investment fund) or persons compensated for soliciting investors (or such person’s affiliates) have been subject to a “disqualifying event.” The Final Bad Actor Rule enumerates applicable disqualifying events, including specified criminal convictions, court injunctions and restraining orders, certain orders of the Commodity Futures Trading Commission or other specified agencies, certain disciplinary orders related to brokers, dealers, municipal securities dealers, investment companies and investments advisers (as well as associated persons), SEC cease and desist orders related to violations of certain anti-fraud provisions and registration requirements under the federal securities laws, certain SEC stop orders, suspensions or expulsions from self-regulatory organizations and US Postal Service false representation orders. 

Unlike the proposed rule, the Final Bad Actor Rules will apply only to disqualifying events occurring after effectiveness of the rule amendments, although pre-existing events would be subject to mandatory disclosure. 

Proposed Rules

In a separate release, the SEC proposed further rule amendments that, if adopted, would:

  • Require an issuer selling securities in reliance upon Rule 506 (i) to file a Form D at least 15 calendar days before engaging in general solicitation for the offering (in the case of an offering pursuant to new paragraph (c) of Rule 506) and (ii) to update the information contained in its Form D and indicate that the offering has concluded within 30 days after completing the offering.
  • Disqualify an issuer that has failed to comply with Form D filing requirements in the previous five years (but without taking into account any non-compliance prior to the adoption of the new rule) from using the Rule 506 exemption in any subsequent offering for a period of one year following the date the Form D is filed, subject to applicable cure periods and potential waivers by the Staff of the SEC.
  • Require legends or cautionary statements in any written general solicitation materials used in a Rule 506 offering.
  • Temporarily require (for a period of two years) issuers to submit written general solicitation materials to the SEC (which materials would not be subject to an SEC comment process or be made publicly available by the SEC).
  • Expand the content required to be included in a Form D, particularly in the context of Rule 506 offerings, such as expanded information regarding the issuer, the offered securities, the types of investors in the offering, the types of general solicitation used, the methods used to verify accredited investor status and the use of proceeds from the offering.
  • Amend Securities Act Rule 156, which currently contains guidance regarding the sales literature used by public funds, to apply that guidance to the sales literature used by private funds generally soliciting under the new rule.

Click here to view the SEC’s adopting release regarding the Final General Solicitation Rules.

Click here to view the SEC’s adopting release regarding the Final Bad Actor Rule. 

Click here to view the SEC’s proposing release regarding the Proposed Rules. 

The Final General Solicitation Rules and the Final Bad Actor Rule will become effective 60 days after their respective publication in the Federal Register. The SEC is seeking public comment on the Proposed Rules, and the comment period ends 60 days after the publication of the Proposed Rules in the Federal Register.

The Final General Solicitation Rules, the Final Bad Actor Rule and the Proposed Rules, including their implications for hedge funds, venture capital funds, private equity funds and other private investment vehicles, will be discussed further in an upcoming Katten Client Advisory

[1] The non-exclusive list of acceptable methods of verifying that a natural person is an accredited investor includes: (i) if accredited status is based on net income, reviewing an Internal Revenue Service form that reports the person’s income for the two most recent years, (ii) if accredited status is verified on the basis of net worth, with respect to the person’s assets, reviewing recent bank or securities account statements, certificates of deposit, tax assessments or independent appraisals, and, with respect to the person’s liabilities, reviewing a recent consumer report from a nationwide consumer reporting agency and obtaining representations that all of the person’s liabilities necessary to make a determination of net worthhave been disclosed to the issuer, (iii) obtaining written confirmation that a registered broker-dealer or investment adviser, a licensed attorney or a certified public accountant has recently verified that the person is an accredited investor or (iv) if the person has previously purchased, and continues to hold, the issuer’s securities, obtaining certification from the person as to his or her accredited investor status.