On July 10, 2013, the SEC at an open meeting (i) adopted final rules eliminating the prohibition against general solicitation and general advertising (hereinafter referred to as a general solicitation) in certain securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act, (ii) adopted final rules preventing felons and other bad actors from participating in private placement offerings, and (iii) proposed rules imposing additional requirements for issuers engaging in general solicitation. The final rules relating to lifting the ban on general solicitation and preventing felons and other bad actors from participating in private placement offerings will be effective 60 days after publication in the Federal Register. The proposed rules relating to the additional requirements are open for comments, which may be submitted on or before 60 days after publication in the Federal Register.
New Rule 506(c) was adopted substantially as proposed by the SEC in August 2012. Upon the effective date, an issuer may choose to rely on new Rule 506(c) to engage in a general solicitation in respect of its offering of securities provided it takes reasonable steps to verify that sales of securities in the offering are made solely to accredited investors. Rule 506(c) is not exclusive and an issuer may conduct a private placement offering of securities as in the past in reliance on Rule 506(b) without engaging in a general solicitation.
Non-Exclusive List of Methods to Verify Accredited Status of Natural Persons
The final Rule 506(c) adds a non-exclusive list of methods for verifying the accredited investor status of natural persons:
Reasonable Steps to Verify Accredited Status of Entities
Rule 506(c) does not provide a similar non-exclusive list for verifying the accredited investor status of entities. In the adopting release, the SEC acknowledges that the reasonable steps to verify the accredited status of entities will necessarily differ from the non-exclusive list provided for natural persons, and offers a few examples:
Principles-Based Facts and Circumstances Method of Verification
As noted in the adopting release, an issuer may alternatively use a principles-based facts and circumstances method of verification taking into account:
Form D will be amended to include a Rule 506(c) check-the-box election and, according to the public statements of the SEC, once elected by an issuer in respect of an offering of securities, the issuer will not be able to switch to, or claim as an alternative, Rule 506(b) as to that offering.
Private Investment Entity Status and Regulation S
Finally, in the adopting release, the SEC (i) stated that private funds may utilize Rule 506(c) and engage in a general solicitation without jeopardizing their status as private investment entities excluded from the definition of “investment company” in the Investment Company Act of 1940 and (ii) reaffirmed that concurrent offshore offerings conducted in compliance with Regulation S will not be integrated with an offering of securities in compliance with Rule 506(c).
CFTC and Solicitations in Foreign Jurisdictions
Private fund sponsors that have registered with the CFTC and rely on CFTC Rule 4.7 or that rely on the CFTC Rule 4.13(a)(3) de minimis exemption from registration are subject to certain CFTC regulations that prohibit marketing to the public. The final rules provide no guidance as to whether permitted general solicitations will be deemed to be “marketing to the public” for these purposes. Absent future guidance from the CFTC to the contrary, sponsors relying on CFTC Rule 4.7 or 4.13(a)(3) may not be able to use general solicitation. In addition, sponsors considering an offering that could include foreign investors should be aware that permitted general solicitations in the U.S. may not necessarily be permitted in certain foreign jurisdictions and should therefore examine the local laws of such jurisdictions with respect to private placements and general solicitation.
In a separate release, the SEC adopted new Rules 506(d) and 506(e) preventing felons and other bad actors from participating in Rule 506 offerings of securities (whether under Rule 506(b) or under Rule 506(c)). As adopted, the disqualifying provisions apply to the bad acts of an issuer and any of its executive officers, investment manager(s), principals, and significant shareholders. Significant shareholder means a shareholder that owns more than 20 percent of the voting securities of the issuer.
Disclosure of Preexisting Events
In adopting these rules the SEC determined not to impose a Rule 506 disqualification based on events preexisting the effective date of the rules. However, in lieu of disqualification, the issuer is required to provide written disclosure to each purchaser of its securities, at a reasonable time prior to sale, of matters that would have triggered disqualification had they occurred before the effective date of the new disqualification provisions. The issuer is obligated to exercise reasonable care in determining whether a disqualification exists. Reasonable care requires a factual inquiry into whether any disqualification exists. The nature and scope of the factual inquiry will depend on the facts and circumstances concerning the issuer and the participants involved.
Included in the final rules is a requirement that Form D be amended to require a certification that the issuer is not disqualified from relying on Regulation D for one of the reasons stated in Rule 505(b)(2)(iii) or Rule 506(d).
The SEC has proposed amendments to Regulation D, Form D, and Rule 156 under the Securities Act in the context of offerings of securities utilizing general solicitation pursuant to Rule 506(c). The proposed rules, if adopted, would:
We will continue examining the implications of the final and proposed rules on private fund sponsors and keep you informed of any further developments.
This article was first published as a Weil Private Equity Alert.
Richard I. Ellenbogen counsels clients on a broad range of securities regulatory and operational matters with particular emphasis on the organization, operations and regulatory compliance of investment management firms, broker-dealers, private funds and other investment vehicles. Venera Ziegler represents sponsors of private investment funds in connection with the organization and operation of such funds with particular emphasis on regulatory advice on investment adviser and investment company laws and regulations and on regulatory compliance.