SEC Proposes Rules to Permit General Solicitation for Private Placement Offerings Limited to Accredited Investors
Foster Swift Business & Corporate Law Report
September 7, 2012
Under the JOBS Act, which became law on April 5, 2012, the SEC is required to issue new rules that permit general solicitation of investors in Rule 506 offerings that are sold only to accredited investors. On August 29, 2012, the SEC issued proposed regulations to address this issue.
First, a little background:
- It is unlawful to sell a security that is not either registered with the SEC or exempt from registration. Registration is extremely expensive, time consuming, and not appropriate for most small companies.
- One available exemption from registration is found in Rule 506 of Regulation D. Rule 506 is considered to be a safe harbor to establish that the issuing company has satisfied a statutory exemption under Section 4(2) of the Securities Act for “transactions by an issuer not involving any public offering.”
- Because of the non-public (private) offering requirement, Rule 506 has historically prohibited general solicitation of investors, since that seems to be public rather than private.
- “General solicitation” refers to any widely disseminated invitation to invest, such as advertisements or other communications published in newspapers or magazines or broadcast over television or radio. Because of the nature of the worldwide web, the SEC has interpreted the posting on the internet of a solicitation of investors or notice of a securities offering to constitute general solicitation.
- State law is pre-empted by federal law for offerings under Rule 506, which makes this exemption particularly attractive.
- Under Regulation D, there are numerous categories of investors who may qualify as “accredited investors” ranging from pension plans and corporations having total assets in excess of $5 million to regulated entities such as banks and investment companies. Natural persons are accredited if they either: have a net worth, or joint net worth with a spouse, in excess of $1 million excluding the value of the investor’s primary residence; or have annual income of $200,000 or joint annual income with a spouse of $300,000 in the year of investment and each of the prior two years.
- Under Rule 506, the issuer may sell securities to an unlimited number of accredited investors without losing the exemption. However, if there are accredited investors with whom the issuer or the issuer’s broker-dealer did not have a pre-existing relationship, the SEC has historically taken the position that general solicitation has occurred and the exemption from registration is not available.
With the advent of the internet, the temptation to use a web posting to solicit investors has landed numerous small companies in hot water. And the reality is that many entrepreneurs do not personally know or have access to very many, if any, accredited investors. The public policy behind this part of the JOBS Act is to allow enterprises to use the internet to search for prospective investors, and so long as they sell securities only to accredited investors, they will be able to use the Rule 506 exemption from registration.
Many of us who practice securities law were worried that the SEC would adopt regulations that would impair the practical benefit of this law change by requiring that investors divulge personal information they would be unwilling to share, such as tax returns. We are pleased to report that the proposed rules do not do this. In its release of the proposed rules, the SEC made repeated reference to its desire to accommodate investor privacy concerns.
Instead of a black and white approach to confirming accredited investor status, the SEC opted for gray. Noting both the investor privacy issue, and the fact that there are numerous paths to being characterized as an accredited investor that require different approaches to verification, the SEC is proposing that issuers who use general solicitation be required to “take reasonable steps to verify” that purchasers of the offered securities are accredited investors. Whether the steps taken are reasonable will be based on the facts and circumstances of each transaction.
Based on the SEC’s extensive discussion of what is “reasonable,” it is clear that the historically common practice of relying only on a signed representation from the investor will not be enough. This traditional approach will need to be supplemented. Possible strategies might be obtaining publicly available average compensation of persons employed in a similar capacity as the investor or a verification of net worth from the investor’s broker-dealer, attorney or accountant. Strategies will likely evolve over time, based on the nature of the general solicitation and experience gathered as companies begin to test this new approach to identifying investors.
Where from here?
There is a 30 day comment period during which the SEC has requested comments about its proposed rule. It is possible that the final rule will be significantly different from, slightly different from, or unchanged from the proposed rule. Because the SEC solicited comments in advance of issuing the proposed rule, we expect that any changes will be modest. We encourage clients to begin to think about how they may be able to utilize this upcoming change for future fundraising activities. Once the final rule is adopted, we look forward to working with clients to select and implement appropriate strategies to utilize this new opportunity for obtaining investment dollars.
Please contact Iris Linder (517-371-8127 or email) or any other Foster Swift attorney for more information.