While many believe the new rules are simply catching up with modern times and are overdue, not everyone welcomed the new rules with open arms. Among the opponents is one of the five SEC commissioners, Luis Aguilar. He voted against the new rules, calling their adoption "reckless." Those who are against the new rules, which include various regulators, lawmakers and consumer protection groups, fault the new rules for not having sufficient investor protections, which, in their view, will make fraud easier and will damage the investing public and investor confidence in US markets.
Under the new rule (which will be contained in new Rule 506(c)), companies can offer securities through means of general solicitation so long as all of the other applicable requirements of Regulation D are satisfied and:
- all purchasers of securities are accredited investors; and
- the company takes reasonable steps to verify that such purchasers are accredited investors.
The Verification Requirement
The new rules include a “safe harbor” list of four methods that companies may use to satisfy the verification requirement for natural persons. The safe harbor methods are non-exclusive, meaning that companies may elect to take other “reasonable steps to verify” the accredited investor status of purchasers. Whether the steps taken are “reasonable” will be an objective determination by the company, in the context of the particular facts and circumstances of each purchaser and transaction. Among the factors that companies should consider are:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the company has about the purchaser; and
- the nature of the offering, such as 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.
The Safe-Harbor Methods
The four safe-harbor methods of verifying accredited investor status apply to natural persons. Of course, notwithstanding compliance with one or more of the safe-harbor methods, the verification requirement will not be deemed satisfied if the company knows that the purchaser is not an accredited investor.
- Income Test. In verifying whether a natural person is an accredited investor on the basis of income, a company is deemed to satisfy the verification requirement by reviewing copies of any IRS form that reports income (e.g., a Form W-2, Form 1099, Schedule K-1, and a filed Form 1040) for the two most recent years, along with obtaining a written representation from such person that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year. In the case of a person who qualifies as an accredited investor based on joint income with that person’s spouse, the company must obtain the IRS forms and representations from both the person and the spouse.
- Net Worth Test. In verifying whether a natural person is an accredited investor on the basis of net worth, a company is deemed to satisfy the verification requirement by reviewing one or more of the following types of documentation, dated within the prior three months, and by obtaining a written representation from such person (and his or her spouse, if the person qualifies as an accredited investor based on joint net worth) that all liabilities necessary to make a determination of net worth have been disclosed:
- Assets: bank and brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties; and
- Liabilities: a credit report from at least one of the nationwide consumer reporting agencies
- Confirmation From Third Parties. A company is deemed to satisfy the verification requirement by obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor.
- Prior Accredited Investor. If a person invested in a company's Rule 506 offering as an accredited investor prior to the effective date of the new rule and remains an investor in the company, for any "new" Rule 506 offering conducted by the same company, the company will be deemed to satisfy the verification requirement with respect to such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.
The “Old” Rule 506 Exemption Remains Available
Even after Rule 506(c) is in effect, companies can continue to use the current Rule 506 exemption (which, of course, would subject the offering to the prohibition against general solicitation). Offerings under current Rule 506 are important because, among other things, companies can sell to non-accredited investors who meet the rule’s sophistication requirements. However, keep in mind that once a general solicitation has been made to the purchasers in an offering, the SEC does not believe the company would be able to rely on the “old” Rule 506.
The Effective Date
The new rules will take effect in 60 days after publication in the Federal Register – so, probably by mid-September.
For an ongoing offering under Rule 506 that commenced before the effective date of the new rule, the company may choose to continue the offering after the effective date in accordance with the requirements of either the existing rule or the new rule. If a company chooses to continue the offering in accordance with the requirements of the new rule, any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales of securities that occurred prior to the effective date in reliance on the existing rule.
Form D Requirement
In connection with the new 506 rule, the SEC adopted revisions to Form D that require companies to indicate that they are relying on the new rule exemption by marking a new check box in Item 6 of Form D.
Under the new rule, securities sold pursuant to Rule 144A can be offered to persons other than QIBs, including by means of general solicitation, provided that the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe to be QIBs.
Other SEC Actions
In addition to adopting the rules relaxing the ban on general solicitation, the SEC also adopted the bad actor provisions for Rule 506 offerings and approved a series of proposals relating to private offerings that are intended to safeguard investors in the new world of general advertising and general solicitation.
The SEC also issued a proposed rule that, if adopted, would (1) require the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation; (2) require the filing of a closing amendment to Form D after the termination of any Rule 506 offering; (3) require written general solicitation materials used in Rule 506(c) offerings to include certain legends and other disclosures; (4) require the submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the SEC; and (5) disqualify a company from relying on Rule 506 for one year for future offerings if the company (or its predecessor or affiliate) did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering.