[Editor’s Note: The following update is authored by Davis Polk & Wardwell LLP]
On July 10, 2013, the SEC adopted amendments to the Regulation D and Rule 144A private-placement safe harbors, as mandated by the JOBS Act of 2012. The amendments, which will become effective on September 23, 2013, will eliminate the prohibition on widespread advertising and other forms of “general solicitation” or “general advertising” in private offerings under Rule 506 of Regulation D of the Securities Act of 1933 or under Rule 144A of the Securities Act of 1933, so long as all purchasers of the securities are reasonably believed to be accredited investors upon taking reasonable steps to verify as much (under Rule 506) or are reasonably believed to be qualified institutional buyers or “QIBs” (under Rule 144A). The amendments, however, did not extend the ability to engage in general solicitation to private placements that are not conducted in reliance on Rule 506 or Rule 144A, such as Section 4(a)(2) of the Securities Act of 1933.
In a companion release, the SEC also adopted amendments to Rule 506 that disqualify issuers from relying on Rule 506 if certain “felons and other bad actors” are participating in the Rule 506 offering, as mandated by the Dodd-Frank Act of 2010. These amendments will become effective at the same date as the above amendments cutting back the general solicitation ban.
Finally, the SEC proposed additional amendments to Regulation D, Form D and Rule 156 under the Securities Act of 1933, which would impose new filing and disclosure requirements on offerings made in reliance on Rule 506. According to the SEC, these amendments are intended to enhance its ability to evaluate the development of market practices in the wake of issuers being permitted to engage in general solicitation in Rule 506 offerings, although two of the SEC’s five commissioners opposed proposing the amendments on the grounds that they are inconsistent with the Congressional intent in the JOBS Act to lift certain limitations on general solicitation. Comments on the proposed amendments are due by September 23, 2013.
We issued a summary of the adopted and proposed amendments in our July 10, 2013 client newsflash. This memo provides a more detailed examination of these amendments and proposals and their implications.
General solicitation or advertising in Rule 506 and Rule 144A offerings
Rule 506 of Regulation D under the Securities Act of 1933 is a non-exclusive safe harbor that permits the unregistered sale of securities in private placements to “accredited investors” (including individuals with more than $1 million in net worth, excluding primary residence, or with annual income of more than $200,000 in the prior two years and a reasonable expectation of meeting the threshold in the current year, and companies with more than $5 million in assets), subject to certain conditions. Until the effective date of the amendments, one of those conditions is that the issuer is precluded from relying on Regulation D if the issuer or any person acting on its behalf offers or sells the securities using any form of general solicitation or advertising.
Rule 144A under the Securities Act of 1933 is also a non-exclusive safe harbor, permitting the unregistered resale of securities to QIBs (which includes institutions with at least $100 million in investment securities). Until the effective date of the amendments, Rule 144A also precludes general solicitation or advertising in the offering as it contains the condition that the securities be offered only to persons reasonably believed to be QIBs, even if all the purchasers end up being QIBs, and any broad general solicitation or general advertising could be viewed as an offer to all recipients, including non- QIBs.
Industry professionals have long noted that each safe harbor restricts offers, despite the requirement that the purchasers be accredited investors or QIBs. The JOBS Act addressed this asymmetry by directing the SEC to amend its rules to permit general solicitation or general advertising in offerings under either safe harbor, so long as the purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify such status (under Rule 506) or are reasonably believed to be QIBs (under Rule 144A). As a result, the SEC’s adoption of these amendments moves the SEC away from regulating offers to regulating only the sale of unregistered securities. Notably, however, these amendments do not extend to private placements not conducted in reliance on Rule 506 or Rule 144A, such as Section 4(a)(2) of the Securities Act of 1933, as we discuss below.
Rule 506 offerings to accredited investors with reasonable verification
The amendments will permit issuers and their designees to make offers to non-accredited investors, including through widespread advertising and other forms of general solicitation as long as the issuer takes “reasonable steps to verify that purchasers of securities sold in [the offering] are accredited investors.” It is important to note that this “reasonable verification” requirement is separate and apart from the requirement that all sales be limited to accredited investors. In other words, reliance on Rule 506’s safe harbor is conditioned on satisfying this “reasonable verification” requirement even if all purchasers in the Rule 506 offering are accredited investors.
The amendments generally do not apply to an issuer electing to conduct a Rule 506 offering without utilizing general solicitation or general advertising. In that case, the issuer would not be required to take reasonable steps to verify the accredited investor status of purchasers, but would need to comply with the current requirement that it have a reasonable belief, at the time of sale, that the purchasers are accredited investors.
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