Schiff Hardin LLP July 11, 2013
Public Company Alert

SEC Adopts Rules Eliminating the Prohibition on General Solicitation and General Advertising in Certain Offerings

On July 10, 2013, the SEC issued final rules eliminating the prohibition on general solicitation and general advertising from Rule 506, the most widely-used exemption from registration of securities under the Securities Act of 1933. The SEC also amended Rule 144A, the exemption for resales of securities to larger institutional investors known as qualified institutional buyers, or QIBs. Rule 144A was amended to eliminate the prohibition of offers to non-QIBs, which had the practical effect of prohibiting general solicitation. The SEC's actions were taken in response to Section 201(a) of the JOBS Act, which mandated the changes as a means to make it easier for issuers to find investors and raise capital. The new rules will take effect 60 days after publication in the Federal Register.

Background

Companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration.

Section 4(a)(2) of the Securities Act exempts the registration of transactions by an issuer "not involving any public offering." In 1981, the SEC adopted Rule 506 of Regulation D as a non-exclusive safe harbor exemption from registration under Section 4(a)(2). In an offering that qualifies for the Rule 506 exemption, an issuer may raise an unlimited amount of capital from an unlimited number of "accredited investors" and up to 35 non-accredited investors. Accredited investors are individuals who meet certain minimum income or net worth levels, registered brokers, dealers and investment companies, and certain institutions such as trusts, corporations, or charitable organizations that meet certain minimum asset levels.

The availability of Rule 506 is subject to a number of requirements and is currently conditioned on the issuer, or any person acting on its behalf, not offering or selling securities through any form of "general solicitation or general advertising." Although the terms "general solicitation" and "general advertising" are not defined, Regulation D does provide examples of general solicitation and general advertising, including advertisements published in newspapers and magazines, communications broadcast over television and radio, and seminars where attendees have been invited by general solicitation and general advertising. By interpretation, the SEC has confirmed that other uses of publicly available media, such as unrestricted websites, also constitute general solicitation and general advertising.

Rule 144A is a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain "restricted securities" (typically, privately placed securities) to QIBs. Although Rule 144A does not include an express prohibition against general solicitation, offers of securities under Rule 144A currently must be limited to QIBs, which has the same practical effect. By its terms, Rule 144A is available solely for resale transactions; however, since the SEC adopted the rule in 1990, many companies have conducted "Rule 144A offerings": a primary offering of securities to one or more financial intermediaries — commonly known as "initial purchasers" — in a transaction that is exempt from registration pursuant to Section 4(a)(2) under the Securities Act, followed by the resale of those securities by the initial purchasers to QIBs in reliance on Rule 144A.

New Rule 506(c)

The final rules include a new Rule 506(c), which permits an issuer to use general solicitation and general advertising to offer its securities provided that:

  • The issuer takes reasonable steps to verify that the investors are accredited investors.
  • All purchasers of the securities fall within one of the categories of persons who are accredited investors under existing Rule 501 of Regulation D, or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.

It is up to each issuer to determine what constitutes reasonable steps to verify accredited investor status, taking into consideration the facts and circumstances of each purchaser and the transaction. Nevertheless, in response to comments on the rules as originally proposed, the final rules provide a non-exclusive list of methods that issuers may use to satisfy the verification requirement for individual investors. These methods include:

  • Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year (to verify minimum income).
  • Reviewing copies of bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties (to verify assets) and a consumer report (also known as a credit report) from at least one of the nationwide consumer reporting agencies (to verify liabilities), in each case to verify minimum net worth.
  • Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser's accredited status.

The SEC release adopting the new rules makes clear that obtaining an investor self-report of net worth or income, by itself, will not constitute "reasonable steps" for purposes of complying with Rule 506(c).

Issuers may continue to rely on the existing provisions of Rule 506, without the use of general solicitation or general advertising, in which case the offering will not be subject to the new verification rule. Such offerings may continue to be made to a limited number of non-accredited investors.

Amended Rule 144A

Under amended Rule 144A, 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. The SEC adopting release makes clear that the use of general solicitation does not affect the ability of the issuer to rely on the Section 4(a)(2) exemption for a sale to an initial purchaser in a Rule 144A offering.

Form D

The final rules also amend Form D, which is the notice that issuers must file with the SEC when they sell securities under Regulation D. The revised form adds a separate box for issuers to check if they are claiming the new Rule 506(c) exemption that would permit general solicitation or general advertising.

Related SEC Rulemakings

In connection with the new rules, the SEC published for comment proposed rules that would require issuers to provide additional information about Rule 506 securities offerings to better enable the SEC to monitor the market with the ban on general solicitation now lifted. The proposal also provides for additional safeguards as this market changes and new practices develop.

The SEC also adopted rules that disqualify felons and other bad actors from participating in certain securities offerings as required by the Dodd-Frank Act.

ABOUT SCHIFF HARDIN LLP

With significant experience in the federal securities laws, Schiff Hardin is well-positioned to provide public companies across the United States with the full range of services necessary to compete effectively in today's global marketplace. Our primary goals are to know our clients, learn their business and their industry, and work closely with them to address the many legal, regulatory and other challenges currently facing public companies.

For more information, see our Web site.