[Editor’s Note: The following post is authored by Kirkland & Ellis LLP]
As discussed in previous PENs, the SEC’s rules governing the sale of unregistered securities by a private “issuer” — including a private fund and a “newco” formed to purchase or invest in a target — have for many years prohibited the issuer from engaging in general solicitation of or general advertising for investors.
As required by the JOBS Act, the SEC recently adopted rule changes eliminating these longstanding restrictions, so long as the issuer performs additional diligence to verify that all securities purchasers are “accredited investors” under Rule 501. The new rules are expected to be effective in mid-September 2013 — 60 days after they are published in the Federal Register — and were adopted in substantially the same form as proposed in August 2012, except that the SEC has introduced four non-exclusive safe harbor methods for verifying the accredited investor status of a natural person.
The SEC concurrently proposed additional investor protection measures that could increase the regulatory burden on an issuer engaging in general solicitation or advertising, as discussed below under SEC Proposes New Private Placement Marketing and Disclosure Requirements and Form D Amendments.
Background
Historically, the SEC’s Rule 506 (which is part of Regulation D) allowed an issuer, including a private fund, to sell securities without any dollar limitation to an unlimited number of accredited investors,1 but only so long as the issuer did not engage in any general solicitation of or general advertising for investors.
The SEC interpreted this general solicitation and advertising ban in private placements to prohibit any publication, broadcasting or use of other mass media methods to solicit investors, so an issuer was required to restrict public statements on websites, in the general media and in public presentations by its (or the sponsor’s) employees.
In addition, the SEC required the issuer (or its sponsor) to have a pre-existing substantive relationship with each potential investor solicited (i.e., a relationship that allows the issuer to reasonably conclude each person being solicited is an accredited investor or is financially sophisticated), including a prohibition against coldcall solicitations, even to institutional investors generally known to be accredited investors. This led many private funds to retain placement agents because the SEC allowed an issuer to market to a placement agent’s preexisting substantive relationships even if the issuer had no such direct relationship.
New Rule 506(c)
Under newly adopted Rule 506(c) of Regulation D, an issuer may engage in general solicitation and advertising in an offering, provided that:
- the issuer takes reasonable steps to verify that each purchaser of its securities is an “accredited investor;”
- either each purchaser of securities is in fact an accredited investor or the issuer reasonably believes, at the time of the sale of the securities, that each purchaser is an accredited investor; and
- the issuer satisfies all of the other requirements of a private placement under Regulation D, such as restrictions on transferability of securities.
However, the SEC preserved the prior Rule 506 exemption (which permits an offering not involving general solicitation or advertising) as new Rule 506(b), which is electively available to an issuer who (a) is sell- ing to non-accredited (as well as accredited) investors and/or (b) does not wish to be subject to Rule 506(c)’s new requirements listed above and is not engaging in general solicitation or advertising.
Click here to read the entire update.