SEC Lifts Ban on General Solicitation in Rule 506 Offerings. The New Rule 506(c) Exemption for General Solicitation Offerings

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Memrandum SEC Lifts Ban n General Slicitatin in Rule 506 Offerings On July 10, 2013, the SEC passed a lng-awaited rule mandated by the JOBS Act t permit certain private fferings under Rule 506 f

1 Memrandum SEC Lifts Ban n General Slicitatin in Rule 506 Offerings On July 10, 2013, the SEC passed a lng-awaited rule mandated by the JOBS Act t permit certain private fferings under Rule 506 f Regulatin D t be cnducted using general slicitatin and advertising. 1 This rule as passed did nt differ significantly frm the SEC s prpsed versin f the rule issued in August In additin, the SEC issued tw cmpanin releases. One is a final rule t impse certain bad actr disqualificatins n participants in Rule 506 fferings. The ther is a prpsed rule that wuld make significant amendments t Frm D filing practices, impse legend and filing requirements fr sales literature used in general slicitatin fferings and extend certain antifraud rules t cver sales literature f private funds. This memrandum summarizes key prvisins f these releases. The New Rule 506(c) Exemptin fr General Slicitatin Offerings Effective Date: The new Rule 506(c) exemptin becmes effective n September 23, Until then, issuers cnducting Rule 506 fferings shuld cntinue t cmply with the ld-style requirements, which include the prhibitin n general slicitatin. Transitin Offerings: Fr fferings started as a cnventinal Rule 506 ffering (nw t be called a Rule 506(b) ffering) that cntinue after the effective date f the new rules, an issuer may elect t start sliciting and advertising after the effective date withut impairing the exempt status f ffers and sales made prir t the effective date in accrdance with the cnventinal Rule 506(b) requirements. Issuers may chse between a 506(b) r 506(c) ffering: An issuer may still elect t cnduct its Rule 506 fferings withut general slicitatin under Rule 506(b) and withut having t cmply with the heightened requirements fr new Rule 506(c) fferings. Private Funds May Cnduct 506(c) Offerings withut impairing exemptins under Sectin 3(c)(1) and 3(c)(7) f the Investment Cmpany Act: Mst private equity, venture capital, hedge and ther similar funds that are nt publicly traded rely n ne f tw exclusins frm the definitin f investment cmpany set frth in Sectin 3(c)(1) and 3(c)(7) f the Investment Cmpany Act, bth f which are cnditined n the issuer nt making r prpsing t make a public ffering f its securities. The SEC affirmed that private funds may cnduct 506(c) fferings withut lsing the benefit f these exclusins. Primary Differences between Old-Style 506(b) Offerings and New 506(c) Slicitatin Offerings Althugh unaccredited investrs are rarely included in any Rule 506 ffering because f the heightened infrmatin requirements triggered by their inclusin, an ld-style 1 Eliminating the Prhibitin Against General Slicitatin and Advertising in Rule 506 and Rule 144A Offerings, Release N ; N ; N. IA-3624, available at Rbinsn Bradshaw & Hinsn, P.A. Attrneys at Law 101 Nrth Tryn Street, Suite 1900 Charltte, NC Charltte Research Triangle Rck Hill

2 Rule 506(b) ffering may include up t 35 unaccredited investrs. All purchasers in Rule 506(c) fferings must be accredited investrs, r AIs. In a Rule 506(c) ffering, an issuer must take reasnable steps t verify that the purchasers are AIs. This requirement is separate frm the requirement that all purchasers be AIs, and failure t cmply with it can cause lss f the exemptin, even if all purchasers turn ut t be AIs. 2 The final rules implementing Rule 506(c) amend Frm D t include separate check bxes in which an issuer must indicate whether it is relying n a Rule 506(b) exemptin r Rule 506(c) exemptin. Prpsed rules, described belw under Prpsed Changes t Frm D, Filing and Infrmatin Requirements fr Rule 506(c) Offerings and Antifraud Guidance fr Private Funds, wuld implement ther significant changes regarding Frm D filing practices, legend requirements n general slicitatin materials, and a requirement that issuers file with the SEC all written general slicitatin materials in Rule 506(c) fferings fr the first tw years after the effective date f the new rule. Satisfying the Reasnable Steps t Verify Requirement Nn-exclusive methds fr Individuals: The rule prvides a nn-exclusive list f methds fr verifying the AI status f individuals: 3 Fr verificatin based n incme, review f tax frms fr the tw mst recent years (such as Frm W-2, 1099, K-1, r 1040), alng with a written representatin that the individual (r cuple, if relying n jint incme) reasnably expects t reach the requisite incme level during the current year. Fr verificatin based n net wrth, review f ne r mre f the fllwing dcuments dated within the prir 3 mnths, alng with a written a representatin frm the purchaser that all liabilities necessary t make a net wrth determinatin have been disclsed: Assets: ne r mre f the fllwing: bank statements, brkerage statements and ther statements f securities hldings, CDs, tax assessments and independent, third party appraisal reprts. Liabilities: a credit reprt frm ne f the natinwide cnsumer reprting agencies. 2 The SEC affirmed its view that that the reasnable belief element f the definitin f accredited investr in Rule 501(a) still applies in the cntext f all Rule 506 fferings. Thus, in a Rule 506(c) ffering, if the issuer had taken reasnable steps t verify, and therefre established a reasnable belief that an investr was an AI, the issuer wuld nt be denied an exemptin if an investr wh was nt an AI prvided false dcumentatin supprting AI status that the issuer had n reasn t believe was false. 3 The SEC prvided the nn-exclusive list f verificatin methds fr individuals because it believes the ptential fr uncertainty and the risk f participatin by nn-accredited investrs is highest in fferings invlving natural persns as purchasers. 2

3 Obtaining written certificatin frm a registered brker-dealer, SEC-registered investment adviser, a licensed attrney r a licensed CPA that such persn r entity has taken reasnable steps t verify within the last 3 mnths that the investr is an AI and has determined that investr is an AI. With respect t subsequent sales by issuers under Rule 506(c) t any existing individual investr wh purchased as an AI in a cnventinal Rule 506 ffering f the issuer prir t September 23, 2013, a certificatin frm the investr at the time f any additinal f sale f securities under Rule 506(c) that the investr qualifies as an AI. General Apprach fr Satisfying the Reasnable Steps t Verify Requirement fr Nn- Individuals: Althugh the reasnable steps t verify requirement applies t all purchasers in a Rule 506(c) ffering, the SEC prvided little specific guidance as t hw this requirement will be met fr nn-individual investrs. As t all purchasers, including individuals (subject t the ptin t use ne f the nn-exclusive listed methds f verificatin), the SEC states that the reasnableness f the verificatin apprach will be an bjective determinatin based n facts and circumstances f the purchaser and transactin and suggests that verificatin shuld be a principles-based apprach in light f cnsideratins such as: the nature f the purchaser and type f accredited investr the purchaser claims t be; the amunt f infrmatin the issuer has abut the purchaser; and the nature f the ffering, such as the manner in which the purchaser was slicited and the terms f the ffering, such as a minimum investment amunt. Using factrs such as thse described abve, the SEC suggests a sliding scale-type apprach, where the mre infrmatin the issuer has abut the investr r the ffering that wuld supprt the reasnable belief that an investr was an AI (e.g., purchaser is an institutinal investr, r the minimum investment amunt is s high that nly accredited investrs wuld likely be t be able t participate), the less the issuer wuld have t d in rder t satisfy the reasnable steps t verify requirement. Mere Check-Off Insufficient: The SEC retained language frm the prpsing release stating its view that, absent additinal infrmatin abut the purchaser indicating AI status, merely having the purchaser check a bx n a questinnaire regarding its status wuld nt cnstitute reasnable steps t verify. It remains t be seen hw market practices will evlve in this regard given the prevalence f the check-bx questinnaire as a cmmn methd f substantiating AI status. N New Guidance n What Cnstitutes General Slicitatin and Advertising: The SEC prvided n new guidance n what cnstitutes general slicitatin r general advertising. The release simply referred t the existing list f examples in Rule 502(c) under Regulatin D (e.g., advertisements in newspapers and magazines, radi and TV cmmunicatins) and subsequent SEC guidance discussing certain uses f electrnic media that cnstitute general slicitatin, such as unrestricted websites. 4 Because f the need fr an issuer t knw 4 See Release N at pp. 6-7 and ftntes referenced therein. 3

4 whether it will be required t cmply with the mre stringent Rule 506(c) requirements, and because f prpsed changes t Frm D discussed belw that wuld require issuers utilizing a Rule 506(c) ffering t file a Frm D n later than 15 days in advance f the first use f general slicitatin in a Rule 506(c), it will be imprtant fr issuers and their advisrs t analyze what types f marketing activities cnstitute general slicitatin and crdinate the cmmencement f these activities s as nt t run aful f any filing r cmpliance requirements. Final Rules Disqualifying Exemptin under Rule 506 fr Offerings invlving Bad Actrs In a related release, 5 the SEC issued final rules mandated by Ddd-Frank t exclude an issuer frm relying n Rule 506 if the issuer r varius affiliated parties and ffering participants 6 have been subject t varius specified disqualifying events, such as criminal cnvictins, securitiesrelated felnies and misdemeanrs, injunctins, regulatry suspensins r bars and similar events. 7 In a significant change frm the prpsed versin f these rules, the disqualificatin will apply nly t triggering events that ccur after the effective date f the rule (September 23, 2013). Hwever, pre-existing triggering events will be subject t mandatry disclsure. This rule will likely necessitate new diligence requirements fr sme issuers in advance f a Rule 506 ffering, such as the distributin f D&O-type questinnaires t affiliates and ffering participants t cnfirm that it is nt disqualified frm using Rule 506. Prpsed Changes t Frm D, Filing and Infrmatin Requirements fr Rule 506(c) Offerings and Antifraud Guidance fr Private Funds 8 Significant changes t timing, cntent and disqualificatin requirements regarding Frm D filings: In a tandem prpsed rule release, 9 the SEC prpsed significant changes t Frm D filing practices in light f the new final rules permitting general slicitatin fferings under Rule 506(c). Specifically, the prpsals wuld require: New Advance Frm D Filing fr 506(c) Offerings: An issuer intending t use Rule 506(c) wuld file an Advance Frm D 15 calendar days prir t the first general 5 Disqualificatin f Felns and ther Bad Actrs Frm Rule 506 Offerings, Release N , available at 6 The actrs wh can trigger the disqualificatin include the issuer; any predecessr f the issuer; any affiliated issuer; any directr, executive fficer, ther fficer participating in the ffering, general partner r managing member f the issuer; any beneficial wner f 20% r mre f the issuer s utstanding vting equity securities, calculated n the basis f vting pwer; any prmter cnnected with the issuer in any capacity at the time f such sale; any investment manager f an issuer that is a pled investment fund; any persn that has been r will be paid (directly r indirectly) remuneratin fr slicitatin f purchasers in cnnectin with such sale f securities; any general partner r managing member f any such investment manager r slicitr; r any directr, executive fficer r ther fficer participating in the ffering f any such investment manager r slicitr r general partner r managing member f such investment manager r slicitr. 7 The full list f disqualifying events is specified in new Rule 506(d) at pp f the release. 8 Fr purpses f these prpsals, a private fund is an issuer that wuld be an investment cmpany, as defined in Sectin 3 f the Investment Cmpany Act, but fr the exclusins frm the definitin f investment cmpany in Sectin 3(c)(1) r Sectin 3(c)(7) f that Act. Mst private equity, venture capital, hedge and ther similar funds that are nt publicly traded rely n these exclusins and are thus private funds under these prpsals. 9 Amendments t Regulatin D, Frm D and Rule 156 under the Securities Act, Release N ; Release N ; Release N. IC-30595, available at 4

5 slicitatin in the ffering. The existing rule requires applicable Frm D filings be made within 15 calendar days after the first sale f securities in the ffering. The existing 15-day pst-sale filing requirement wuld be retained fr Rule 506(b) fferings and 506(c) fferings in which all the required infrmatin was nt prvided in an earlier Frm D filing. New Clsing Amendment Filing fr all 506 Offerings: A clsing amendment t a Frm D wuld be filed within 30 calendar days after terminatin (meaning either the last sale in r abandnment f an ffering) f a Rule 506 ffering, whether cnducted under Rule 506(b) r (c). 10 Mre Extensive Infrmatin in Frm D filings: Mre extensive infrmatin abut the ffering and in sme cases, ffering participants and their affiliated parties, wuld be required in new Frm D items. These new items wuld include, amng thers: (1) a listing in Rule 506(c) fferings f each persn wh directly r indirectly cntrls the issuer; (2) a breakdwn in all Rule 506 fferings f the number f purchasers wh qualify as AIs based n the particular categry in Rule 501(a) in which the purchaser qualifies (e.g., incme, net wrth, etc.); (3) a listing in Rule 506(c) fferings f all types f general slicitatin used r t be used; and (4) a listing in Rule 506(c) fferings f the methds used r t be used t verify the AI status f purchasers. Stricter Disqualificatin Standards based n Frm D Nncmpliance: An issuer wuld be disqualified frm relying n Rule 506 fr ne year if the issuer, any predecessr r an affiliate f the issuer did nt cmply with all applicable Frm D filing requirements. Unlike existing Rule 507, which impses disqualificatin nly if the issuer has been subject t curt actin fr failure t cmply, the new disqualificatin wuld be self-executing and apply simply based n the issuer s failure t cmply. Only nn-cmpliance after effectiveness f the prpsed rules wuld trigger a disqualificatin, s that an issuer wuld nt have t lk back past that effective date t assess cmpliance. 11 The disqualificatin wuld als be subject t a single 30-calendar day cure perid per ffering in which the issuer culd file ne delinquent Frm D r amendment required fr a particular ffering withut becming subject t the disqualificatin. The SEC wuld als retain prvisins permitting issuers t seek waiver f the disqualificatin upn shwing f gd cause. Like current Rule 507, the disqualificatin wuld apply nly t future fferings and nt affect the exemptin fr the ffering in which the nn-cmpliance ccurred. The neyear disqualificatin perid begins t run nly after the issuer has caught up n all delinquent Frm D filings. Legend and Filing Requirements fr Sales Literature: The prpsed rules wuld als require all issuers t include certain legends n all written materials used in Rule 506(c) 10 The clsing amendment wuld nt be required if a previusly filed Frm D cntained all infrmatin required t be included in the clsing amendment and indicated that it was the clsing amendment. 11 Under the prpsed rule, the issuer wuld eventually be subject t disqualificatin based n filing nncmpliance that ccurred during the preceding 5 years. Hwever, in light f the transitin aspect f the rule that impses disqualificatin fr nncmpliance that ccurs nly after the effective date f the new rules, the 5-year lk back will be prspective starting with the effective date f the new rules. 5

6 general slicitatins 12 and additinal legends and disclsures in any private fund written general slicitatin materials that include perfrmance data. 13 Filing f Rule 506(c) Written General Slicitatin Materials with the SEC: The prpsals wuld als require, fr the first 2 years fllwing the effective date f the prpsed rule, that all issuers cnducting a Rule 506(c) ffering submit t the SEC, prir t their first use, any written cmmunicatin that cnstitutes a general slicitatin r general advertising. Althugh nt entirely clear, the wrding f the prpsed rule suggests that underlying sales materials, such as private placement memranda, which are privately prvided t prspective investrs wh indicate interest after being generally slicited, wuld nt have t be filed, prvided that this literature is nt s bradly disseminated as t itself cnstitute a general slicitatin. The general slicitatin materials wuld be submitted thrugh a newly established SEC intake prtal and wuld nt be available publicly thrugh the SEC s EDGAR filing system. These materials als wuld nt be deemed filed r furnished fr purpses f Securities Act and Exchange Act liabilities. An pen questin is whether these materials culd be btained thrugh a Freedm f Infrmatin Act request. The SEC s stated purpse in prpsing this requirement is t allw it t assess market develpments and practices fllwing the effectiveness f new Rule 506(c). Amendments t Rule 156 t Apply t Sales Literature f Private Funds: Current rule 156 is an elabratin n the general antifraud rules under the Securities Act and Exchange Act, including Rule 10b-5, that applies t sales literature f investment cmpanies and cntains varius examples f statements and representatins in such sales literature that culd be deemed misleading, such as unqualified representatins regarding past r future perfrmance, prtrayals f past results that may expressly r impliedly cnvey misleading inferences abut past r future results, exaggerated r unsubstantiated claims abut management skills r techniques and similar statements. Prpsed amendments t Rule 12 The general legend required n any written Rule 506(c) general slicitatin literature wuld have t include the fllwing statements: (1) The securities may be sld nly t accredited investrs, which fr natural persns are investrs wh meet certain minimum annual incme r net wrth threshlds; (2) The securities are being ffered in reliance n an exemptin frm the registratin requirements f the Securities Act and are nt required t cmply with specific disclsure requirements that apply t registratin under the Securities Act; (3) The Cmmissin has nt passed upn the merits f r given its apprval t the securities, the terms f the ffering, r the accuracy r cmpleteness f any ffering materials; (4) The securities are subject t legal restrictins n transfer and resale and investrs shuld nt assume they will be able t resell their securities; and (5) Investing in securities invlves risk, and investrs shuld be able t bear the lss f their investment. 13 Private funds relying n Rule 506(c) wuld have t prvide a legend disclsing that the securities ffered are nt subject t the prtectins f the Investment Cmpany Act. If the slicitatin includes perfrmance data, the fllwing additinal disclsure requirements wuld apply: (1) a legend disclsing that the perfrmance data represents past perfrmance; that past perfrmance des nt guarantee future results; that current perfrmance may be lwer r higher than the perfrmance data presented; that the private fund is nt required by law t fllw any standard methdlgy when calculating and representing perfrmance data; and that the perfrmance f the private fund may nt be directly cmparable t the perfrmance f ther funds. The legend shuld als identify either a telephne number r a website where an investr may btain current perfrmance data; (2) all perfrmance data must be as f the mst recent practicable date cnsidering the type f private fund and the media thrugh which the data will be cnveyed, and the private fund must disclse the perid fr which perfrmance is presented; and (3) if the perfrmance presentatin des nt include the deductin f fees and expenses, the private fund must disclse that the presentatin des nt reflect the deductin f fees and expenses and that if such fees and expenses had been deducted, perfrmance may be lwer than presented. 6

7 156 wuld extend the cverage f these antifraud guidelines t sales literature f private funds, whether r nt used in a Rule 506(c) general slicitatin. Crdinatin issues with Final Rules Authrizing Rule 506(c) Offerings: It remains t be seen hw market practices with regard t Rule 506(c) fferings may develp during the interim perid between September 23, 2013, when Rule 506(c) fferings will technically be permissible under the final rules, and finalizatin f the prpsed rules regarding Frm D filings and ther infrmatinal requirements relating t Rule 506(c) fferings, fr which the cmment perid will expire n September 23, Given the implicit and explicit statements in the prpsed release that the Frm D and related infrmatinal refrms are intended t mnitr and curb ptential abuses arising frm the liberalizatin f ffering practices under Rule 506(c), issuers may be best served by prceeding cautiusly during this interim perid until additinal guidance is prvided regarding the crdinatin and ptential applicatin f these prpsed requirements t Rule 506(c) fferings cnducted prir t finalizatin f the prpsed rules. Observatins Althugh remval f the ban n general slicitatin in Rule 506 fferings may dramatically alter market practices, these rules, alng with related rule prpsals, may impse significant cmplexities, uncertainties and cmpliance respnsibilities n issuers, such as the prpsed requirements t file a Frm D 15 calendar days prir t a cntemplated general slicitatin, prvide mre extensive infrmatin in Frm D and file all written general slicitatin materials with the SEC prir t first use. Satisfying these requirements will require discipline and fresight and may prve incmpatible t sme extent with the certainty, spntaneity and relative privacy assciated with current private ffering practices. Each issuer will need t carefully assess whether availing itself f a general slicitatin ffering is wrth these csts and the heightened prfile an issuer may assume n federal and state securities regulatrs radar as the result f these requirements. Because general slicitatin fferings will nt be permitted until September 23, 2013 at the earliest, and because ld-style Rule 506 fferings are still available using familiar practices, issuers may want t see hw develpments, final rules and interpretatins and market practices unfld befre embarking n a general slicitatin ffering. Patrick S. Bryant July 24, 2013 Rbinsn Bradshaw & Hinsn, P.A. ffers this memrandum as general infrmatin. It is nt intended as specific legal advice fr a particular situatin. If yu wuld like additinal infrmatin n this tpic, please cntact Patrick Bryant r any ther attrney with whm yu wrk at ur firm. 7

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