[Editor’s Note: The following post is authored by Arnold & Porter LLP]
On July 10, 2013, the Securities and Exchange Commission (SEC) adopted final rules (Final Rules) eliminating the ban on general solicitation and general advertising for private securities offerings under Rule 506 of Regulation D under the Securities Act (Regulation D) and Rule 144A under the Securities Act (Rule 144A). The Final Rules also make Rule 506 unavailable for offerings if the issuer or any related “covered person” is a “bad actor” (i.e., has engaged in a “disqualifying event”). The adoption of these rules by the SEC was required under Section 201(a) of the Jumpstart Our Business Startups Act (JOBS Act) and Section 926 of the Dodd- Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), respectively. The Final Rules will go into effect 60 days after publication in the Federal Register.
In connection with the adoption of the Final Rules, the SEC also proposed certain rule amendments that, if adopted, would impose significant new requirements on Regulation D offerings. These proposed amendments stem from concerns raised by commentators and SEC commissioners that permitting general solicitation and general advertising in private securities offerings, without additional protections, is inconsistent with the goal of investor protection and will result in an increase in fraudulent activity in the private placement market.
The adoption of the Final Rules represents a significant shift from the SEC’s longstanding view that securities only be sold pursuant to SEC registration, or otherwise privately, with substantially no solicitation or advertising. This advisory summarizes the Final Rules and proposed rules and discusses some of the more important practical effects of the Final Rules — particularly permitting general solicitation and general advertising — on market participants, including start-up and emerging companies, private funds, registered broker-dealers and issuers and underwriters who engage in concurrent U.S. and offshore private securities offerings.
Elimination of Ban on General Solicitation for Certain Rule 506 Offerings
Background
An issuer who seeks to offer and sell securities in the United States must either register the offering under the Securities Act of 1933 (Securities Act) by filing a registration statement with the SEC or rely on an exemption from the registration requirements of the Securities Act. Section 4(a)(2) of the Securities Act (formerly Section 4(2) of the Securities Act) exempts securities offerings by issuers that do not involve a “public offering.” The courts and the SEC have developed a substantial body of judicial interpretations and administrative guidance interpreting the phrase “not involving a public offering.” One factor is whether the issuer engaged in any general solicitation or general advertising relating to the securities being offered and sold. Examples of general solicitation and general advertising include advertisements published in newspapers and magazines, communications broadcast over television and radio, information available on unrestricted websites, and seminars where attendees have been invited by means of general solicitation or general advertising. Forms of general solicitation and general advertising that may find more utilization after effectiveness of the Final Rules include social media, forms of short-term static advertising such as kiosks, and offers to potential investors who have no “preexisting, substantive relationship” with the issuer or its agent.
The SEC adopted Regulation D in 1982 to provide issuers with a non-exclusive safe harbor from the registration requirements of the Securities Act. An issuer that makes a securities offering in compliance with Regulation D can be confident that the offering does not in fact “involve a public offering,” and is therefore exempt from the registration requirements of the Securities Act. In addition, because the Regulation D safe harbor has historically been non-exclusive, the issuer could rely on the registration exemption under Section 4(a)(2) of the Securities Act even if the offering failed to satisfy all of the requirements of Regulation D.
Prior to the effectiveness of the Final Rules, Regulation D included three available safe harbors from the registration requirement of the Securities Act, as follows:
- for offerings up to US$1 million under Rule 504 of Regulation D;
- for offerings up to US$5 million under Rule 505 of Regulation D; and
- for offerings without regard to dollar amount under Rule 506 of Regulation D.
Historically, issuers have relied on the Rule 506 safe harbor most frequently, which permitted an issuer to offer and sell an unlimited amount of securities without registration under the Securities Act if (among other things):
- the issuer sells the securities to an unlimited number of “accredited investors” (as defined in Rule 501(a) of Regulation D);
- the issuer sells the securities to not more than 35 investors who are not accredited investors but meet certain requirements for being sophisticated investors; and
- neither the issuer nor any person acting on its behalf offers or sells the securities through any form of general solicitation or general advertising.
In April 2012, Congress passed the JOBS Act, which required, among other things, that the SEC eliminate the ban on general solicitation and general advertising in private securities offerings under Rule 506 of Regulation D. The intention underlying this mandate in the JOBS Act is to facilitate capital raising by permitting issuers to use previously unavailable solicitation and advertising methods to seek investors and thereby encourage the creation of new jobs.
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