Of Billboards and Advertisements

As mandated by Congress under the Jumpstart Our Business Startups Act or JOBS Act, the Securities and Exchange Commission has proposed amendments to its rules to eliminate the prohibition against general solicitation and general advertising in certain private placement securities offerings. Proposed new Rule 506(c) would permit the use of general solicitation to offer and sell securities to an unlimited number of purchasers under Rule 506 of Regulation D, provided that certain conditions are satisfied. These conditions are:

• All purchasers of securities 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 
• The issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors.

Similarly, proposed new Rule 144A(d)(1) would provide that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers (QIBs), provided that the securities are sold only to persons that the seller and any person acting on its behalf reasonably believe are QIBs. The Commission also proposed to revise Form D to add a separate check box for issuers to indicate whether they are using general solicitation or general advertising in a Rule 506 offering. The definition of accredited investor, however, remains unchanged by the proposed rulemaking and includes persons that come within any of the listed categories of accredited investors, as well as persons that the issuer “reasonably believes” come within any such category. 

According to Chairman Schapiro, “the proposed rules fulfill Congress's clear directive that issuers be given the ability to communicate freely to attract the capital they need, 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.”

The proposing release notes that the SEC is preserving, under Rule 506(b), the existing ability of issuers to conduct Rule 506 offerings without the use of general solicitation.  In this regard, the continued availability of existing Rule 506 will be important for those issuers that do not wish to engage in general solicitation in their Rule 506 offerings and thus become subject to the new requirement to take reasonable steps to verify the accredited investor status of the purchasers. As such, the proposed amendments would allow issuers to continue to conduct offerings under Rule 506 as it currently exists.

Reasonable Steps to Verify. Consistent with statutory mandate, the proposed rules would require an issuer that uses general solicitation to "take reasonable steps to verify" that all of the purchasers are accredited investors. Rather than providing bright line guidance, the proposed rules take a principles-based approach, so that whether the steps taken are reasonable would be an objective determination, based on the particular facts and circumstances of each offering and investor. Proposed Rule 506(c)(2)(ii) in its entirety provides, "The issuer shall take reasonable steps to verify that purchasers of securities sold in any offering under [Rule 506] are accredited investors." According to the SEC, proposing specific verification methods that an issuer must use “would be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor, as well as the potentially wide range of verification issues that may arise." 

In determining the reasonableness of the steps that an issuer has taken to verify that a purchaser is an accredited investor, the proposing release explains that issuers are to consider the facts and circumstances of the transaction, such as the type of purchaser and the type of accredited investor that the purchaser claims to be, the amount and type of information that the issuer has about the purchaser, 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. 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 reasonably reliable third party. The SEC has made clear, however, that reasonable steps to verify accredited investor status do not include instances where a prospective investor self-certifies his status by merely checking a box in a questionnaire or signing a form, absent other information. 

On the other hand, according to the proposing release, the more information an issuer has that indicates a prospective purchaser is an accredited investor, the fewer steps it would have to take, “and vice versa.” Further, in a footnote to the release, the SEC states that, “if an issuer has actual knowledge that the purchaser is an accredited investor, then the issuer would not have to take any steps at all.” The SEC warns, however, that regardless of the particular steps taken (or not), it would be important for issuers “to retain adequate records that document the steps taken to verify that a purchaser was an accredited investor.”

The SEC even suggested that third parties may develop services that verify a person’s accredited investor status for purposes of Rule 506(c). Such a third-party service, as opposed to the issuer itself, could obtain appropriate documentation or otherwise verify accredited investor status, provided that the issuer has a reasonable basis to rely on such third-party verification. Nevertheless, the proposing release states that many practices currently used by issuers in connection with existing Rule 506 offerings “would satisfy the verification requirement proposed for offerings pursuant to Rule 506(c).”

Finally, in the event a prospective purchaser were to provide false information or documentation to an issuer in order to purchase securities in an offering made under Rule 506(c), the issuer—according to the SEC—would not lose the ability to rely on the Rule 506(c) exemption for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

Form D. An issuer offering or selling securities under Regulation D must file a notice of sales on Form D with the SEC for each new offering no later than 15 calendar days after the first sale of securities in the offering. As part of the proposed Rule 506(c) exemption, the SEC is proposing a revision to Form D to add a new checkbox to Item 6 though which issuers would indicate whether they are relying on proposed Rule 506(c) exemption and thus conducting a general solicitation of potential purchasers.

SEC Monitoring. While the SEC is soliciting comments on a variety of possible approaches to verification of accredited investor status, it has made clear its intention to monitor and study the development of verification practices by issuers. In addition, with respect to the proposed change to Form D, the proposing release notes that the SEC is requiring this information in order to assist its efforts to monitor the use of general solicitation in Rule 506(c) offerings. This information will also help the SEC look into the practices that develop to satisfy the verification requirement. In this way, the SEC staff will be able to assess the effectiveness of various verification practices in identifying and excluding non-accredited investors from participation in proposed Rule 506(c) offerings, as well as to identify those offerings that may call for an enforcement inquiry. 

For more information about proposed new Rule 506(c), please contact the author of this alert, Robert Murphy at 202-906-8721, D. Richard McDonald, who leads Dykema's Public Company practice, at 248-203-0859, or any of the listed attorneys. 

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