Private Offering Reform

Transcription

1 SEC Publishes Details of Proposed New Exemption Permitting Limited Publicity in Unregistered Offerings SUMMARY The Securities and Exchange Commission has published the text of proposed revisions to Regulation D that broaden the private placement exemption. The proposals would: Add a new Regulation D exemption for offers and sales of securities to large accredited investors, a newly defined subset of accredited investors with respect to which limited public tombstone advertising would be permitted; Add an investments owned alternative for a legal entity or natural person to qualify as an accredited investor under the existing Regulation D exemptions; Shorten the integration safe harbor from six months to 90 days; Provide guidance on the integration of concurrent public and private offerings that is generally consistent with the SEC staff s past interpretative guidance on this point; Apply bad actor disqualification provisions to all Regulation D offerings; and Seek additional comments on the 2006 proposal to revise the definition of accredited investor as it relates to natural persons investing in certain privately offered pooled investment vehicles, by adding a further requirement that these persons must own not less than $2.5 million in investments. A separately published proposal would simplify, restructure and update Form D, and would require electronic filing of Form D. The proposals were initially approved at the SEC s public meeting on May 23, 2007, but the actual text was only recently published. Comments on the substantive proposals are due on or before October 7, Comments on the separate proposals relating to Form D are due on or before September 7, The releases do not indicate when the proposed revisions, if adopted, would become effective. New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 BACKGROUND In April 2006, the SEC-created Advisory Committee on Smaller Public Companies issued its report on the regulatory system for smaller companies under the securities laws, including the impact of the Sarbanes- Oxley Act of The report contained a number of recommendations to streamline and simplify the reporting and registration requirements for smaller companies, and also contained recommendations relating to unregistered offerings, including changes to Regulation D, that would apply to all companies. In March 2007, a committee of the American Bar Association submitted a letter to the SEC containing recommendations for a comprehensive overhaul of the securities laws governing unregistered offerings, including Regulation D. 2 The SEC s current proposals advance some (though far from all) of the recommendations included in the Advisory Committee report and the ABA letter. However, the SEC s proposals do not eliminate the broad restrictions on general advertising and general solicitation in Regulation D offerings and do not provide increased flexibility to conduct private and public offerings near in time to each other. IMPLICATIONS The proposed new exemption for offerings to large accredited investors could increase flexibility in how exempt offerings are conducted because limited public announcements would be expressly permitted. In addition, it appears that this limited tombstone publicity would also be permitted in Rule 144A offerings. On the other hand, constraints on the information permitted in the tombstone announcements and the requirement that they be made in writing may limit practical effects of these changes. The other changes in the proposals are modest and not likely to have significant practical implications. DESCRIPTION OF PROPOSED REVISIONS Permitting Limited Public Advertising in Exempt Offerings to Large Accredited Investors New definition of large accredited investors. Regulation D provides a number of exemptions from registration for certain securities offerings by issuers, contingent on factors such as the number and sophistication of purchasers and the manner of offering. The proposals 3 would add a new Regulation D See Final Report of the Advisory Committee on Smaller Public Companies (Apr. 23, 2006), available at See Letter from the Committee on Federal Regulation of Securities of the ABA s Business Law Section to John W. White, Director, SEC Division of Corporation Finance (Mar. 22, 2007), available at The substantive Regulation D proposals are set forth in Rel. No , Revisions of Limited Offering Exemptions in Regulation D (Aug. 3, 2007), 72 Fed. Reg. 45,115 (Aug. 10, 2007), available at -2-

3 exemption, codified as Rule 507 under the Securities Act of 1933, permitting some publicity for offers and sales of securities to a newly defined category of large accredited investors. This category would be a subset of the current category of accredited investors, but using higher monetary thresholds. 4 Specifically: Legal entities that would be considered accredited investors if they have assets or investments in excess of $5 million 5 would be considered large accredited investors only if they have investments in excess of $10 million. Legal entities that qualify as accredited investors without needing to meet dollar thresholds (such as banks, registered broker-dealers, insurance companies and registered investment companies) would also be considered large accredited investors. A natural person would be a large accredited investor if he or she has over $2.5 million in investments (including joint investments with a spouse), as compared to having investments in excess of $750,000 or net worth of $1 million as would be necessary for accredited investor status. 6 A natural person would be a large accredited investor if he or she had an individual annual income of over $400,000 or a combined income with a spouse of over $600,000 in each of the two most recent years, with a reasonable expectation of reaching the same income level in the current year. These amounts are double the thresholds applied in determining accredited investor status. A person who is a director, executive officer or general partner of the issuer would be a large accredited investor, as well as an accredited investor, with respect to that issuer. Under new Rule 507, all purchasers must be large accredited investors. 7 In contrast, an offering under existing Rule 506 could include up to 35 purchasers who are not accredited investors if the requisite information is furnished. 8 As under Rule 506, there would be no limit on the total amount of securities or the number of offerees or purchasers in a Rule 507 offering Under the proposals, all monetary thresholds in Regulation D, including those in the definitions of large accredited investor and accredited investor, would be adjusted for inflation every five years, with the first adjustment to occur on July 1, As discussed in the next section below, the proposals would add an investments owned alternative to the accredited investor test such that an institutional investor would qualify as an accredited investor if it had in excess of $5 million in assets or investments. The investments owned alternative of the accredited investor test would be added by the proposals, as discussed in the next section below. The proposing release states that a Rule 507 offering could be conducted simultaneously or side-byside with another Regulation D offering only if the two offerings would not be integrated under the SEC s five-factor integration test set forth in Rule 502(a). Under that test, it appears unlikely that a Rule 507 offer could be conducted concurrently with a Rule 506 offering of the same security for the same consideration and same purpose. The required information is generally equivalent to that required in a Securities Act registration statement. -3-

4 Permitted advertising. Offerings to Rule 507 qualified purchasers could entail limited advertising, similar to the limited tombstone advertisement permitted for registered securities offerings. This is in contrast to other Regulation D offerings with respect to which no form of general solicitation or general advertising is permitted. The Rule 507 advertisement must be in written form, which would include newspaper and internet publication but not include radio or television advertisements. 9 The advertisement would be permitted to contain: The issuer s name and address; A description of the issuer s business in 25 words or less; The name, type, number, price and aggregate amount of securities being offered and a brief description of the securities; Any suitability standard and minimum investment requirements for prospective purchasers; and Whom to contact for additional information. The advertisement would be required to state prominently that sales will be made only to large accredited investors, that no money or other consideration is being solicited and that the securities will not be registered with the SEC. Additional information could be provided orally or in writing by the issuer or its agent to anyone that the issuer reasonably believes is a large accredited investor, including through an electronic database restricted to large accredited investors. Relationship to Rule 144A offerings. The SEC is proposing to amend Rule 144A to state that a public tombstone advertisement published in a Rule 507 offering will not preclude the availability of the Rule 144A exemption for resales. 10 Thus, it appears that an issuer could sell securities under new Rule 507 (including filing a Form D) to investment banks that are large accredited investors utilizing a public tombstone, and the investment banks could make immediate resales to QIBs under Rule 144A. Commenters will undoubtedly request the SEC to clarify the viability of this technique in the release adjusting the final rule, and to seek a modification that avoids a Form D filing requirement. New Investments Owned Alternative to Qualifying as an Accredited Investor The proposals would broaden the existing Regulation D definition of accredited investor by adding an alternative qualification basis relating to the total investments owned by a purchaser, in addition to the 9 10 Proposed Rule 507 contains a narrower definition of in written form than the Rule 405 definition applicable to free writing prospectuses in public offerings. As proposed, the Rule 507 exemption would be available only for issuer sales, and not for resales. Similarly, the SEC has not proposed to extend Rule 506 of Regulation D to resales, as recommended in the ABA letter. Thus, there would continue to be no safe harbor exemption for resales to accredited investors, even if the other requirements of Rule 506 are satisfied. -4-

5 existing standards which generally relate to total assets or net worth of the purchaser, or income in the case of a natural person. In particular, under the proposals: A legal entity would be an accredited investor if it has either assets or investments in excess of $5 million. Under the current definition, the test is based solely on assets, not investments. A natural person would be an accredited investor if he or she has either investments (including joint investments with a spouse) in excess of $750,000 or net worth (including aggregate net worth with a spouse) in excess of $1 million. The current definition has only the net worth prong of this test. The alternative method of qualification based on annual income would remain unchanged. 11 The proposal would add definitions for investments and joint investments. Investments would include securities (other than those representing a control interest in an issuer), real estate held for investment purposes, commodity interests held for investment purposes, physical commodities held for investment purposes, financial contracts which are not securities entered into for investment purposes, and cash and cash equivalents (including foreign currencies) held for investment purposes, in each case including investments held in retirement plans and trusts. Investments would not include the value of personal residences and places of business. The proposed definition of joint investments provides that investments of an individual seeking to make an investment without obtaining the signature and binding commitment of his or her spouse may include only 50% of any investments (i) held jointly with that person s spouse and (ii) in which that person shares a community property or similar shared ownership interest with that person s spouse. Where both spouses sign and make a binding commitment in a joint investment, the full amount of all their investments (whether or not the investments are held jointly) would be included for purposes of determining whether each spouse is an accredited investor. The existing non-quantitative standards for qualification as an accredited investor would remain largely unchanged. 12 Integration Safe Harbor and Guidance Regulation D provides guidance on the circumstances under which a Regulation D offering would be subject to integration with other offerings by the issuer, and the current rules include a safe harbor pursuant to which offerings will not be integrated if they occur more than six months apart. The proposals would shorten this safe harbor period from six months to 90 days. The SEC rejected the suggestions by The existing income-based test is satisfied if the investor had an individual annual income of over $200,000 or a combined income with a spouse of over $300,000 in each of the two most recent years with a reasonable expectation of reaching the same income level in the current year. These include specified types of regulated legal entities, such as banks, registered broker-dealers, insurance companies and registered investment companies, and any person who is a director, executive officer or general partner of the issuer. -5-

6 the ABA and by its own Advisory Committee to shorten the safe harbor to 30 days, indicating that such a short period could, in effect, result in a public offering under the guise of a series of private offerings. In addition, in an effort to provide a framework for issuers and their counsel to analyze whether concurrent private public offerings would be integrated, the proposing release provides the following guidance: A company s contemplation of filing a registration statement for a public offering at the same time it is conducting a private placement will not cause the Section 4(2) exemption to be unavailable for that private placement, despite the reference in Rule 152 under the Securities Act to a company subsequently decid[ing] to make a public offering. This dovetails with the SEC staff s view that a completed private placement should not be integrated with a public offering registered on a subsequently filed registration statement. The filing of a registration statement does not necessarily eliminate a company s ability to conduct a concurrent private offering. The determination as to whether the filing of the registration statement should be considered a general solicitation or advertising that would affect the availability of an exemption for the private placement depends on the factual question of whether some or all of the private placement investors were solicited by the registration statement, or whether all private placement investors became interested in the offering through other means, such as a substantive pre-existing relationship or other direct contact with the company or its agents. This is consistent with the approach previously taken by the SEC staff in addressing specific integration questions. The guidance on integration is phrased so as to be effective immediately, regardless of whether the proposals in the release are ultimately adopted. Disqualification Provisions The proposals would also revise Regulation D to update and standardize the bad actor disqualification provisions and make them applicable to all Regulation D offerings. Under the current rules only Rule 505, relating to offers and sales not exceeding $5 million, contains a bad actor disqualification provision. The proposed disqualification provisions would be similar to the provision that currently applies to Rule 505, except that it would not extend to underwriters, since underwriters do not directly control the issuer or determine whether to conduct an offering. The disqualification provision would extend to the issuer and its predecessors and affiliates, any director, executive officer, general partner or managing member, any 20% stockholder and any promoter that had been subject to various disqualification events, including a regulatory determination within the last five years of violation of specified financial laws. The SEC Director of Corporation Finance would have delegated authority to waive the disqualification upon a showing of good cause. Reproposal of Accredited Natural Person Standard for Investing in Pooled Investment Vehicles In December 2006, the SEC proposed to add a new category of accredited investor, referred to as an accredited natural person, which would include all accredited investors who are natural persons with -6-

7 over $2.5 million in investments. 13 This proposed revision was intended to ensure that individuals investing in hedge funds and other private funds meet minimum standards of financial sophistication and capacity that may not be fully covered by the definition s existing income and net worth tests. The SEC is now reproposing this new category without change and soliciting further comments in light of the other new proposals. If adopted, the changes would apply only to those private funds (other than venture capital funds) that rely on the exemption from registration under the Investment Company Act of 1940 requiring their securities to be owned by no more than 100 beneficial owners. The changes would have no effect on private funds that rely on the alternative Investment Company Act exemption requiring their securities to be owned exclusively by qualified purchasers. Form D The SEC had separately published its proposals relating to the electronic filing of and revisions to Form D. 14 Form D is required to be filed within 15 days of an issuer s first sale in an offering under Regulation D, including exempt offerings to large accredited investors under proposed new Rule 507. The proposals would require electronic filing of Form D, with the information in these electronic filings to become part of a publicly available, interactive, fully searchable database. The electronic filing system would be designed to permit improved coordination between the SEC and state securities regulators, which use Form D filings as a basis for their own oversight of the exempt securities transaction market. The SEC expresses its hope that state securities regulators will rely on Form D filings for their own notification requirements, in order to avoid duplicative filings, though this will likely vary from state to state. The proposals would provide an exemption from the restriction in Regulation D on general solicitation and general advertising for information provided in a good faith and reasonable effort to comply with the requirements of Form D. * * * See Rel. No , Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles; Accredited Investors in Certain Private Investment Vehicles (Dec. 27, 2006), 72 Fed. Reg. 400 (Jan. 4, 2007), available at This proposal also included new rules under the Investment Company Act of 1940 to prohibit investment adviser fraud, but those are not addressed in the current proposal and have not yet been adopted. The December 2006 proposals are discussed in more detail in our memorandum, dated January 12, 2007, entitled The SEC Publishes Proposed Rules to Raise Accredited Investor Standards for Certain Private Investment Funds and to Prohibit Investment Adviser Fraud. The Form D proposals are set forth in Rel. No , Electronic Filing and Simplification of Form D (June 29, 2007), 72 Fed. Reg (July 9, 2007), available at Copyright Sullivan & Cromwell LLP

8 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance and corporate transactions, significant litigation and corporate investigations, and complex regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 600 lawyers on four continents, with four offices in the U.S., including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Jennifer Rish ( ; rishj@sullcrom.com) or Alison Alifano ( ; alifanoa@sullcrom.com) in our New York office. CONTACTS New York John E. Baumgardner, Jr baumgardnerj@sullcrom.com John T. Bostelman bostelmanj@sullcrom.com Robert E. Buckholz, Jr buckholzr@sullcrom.com Catherine M. Clarkin clarkinc@sullcrom.com Jay Clayton claytonwj@sullcrom.com H. Rodgin Cohen cohenhr@sullcrom.com David B. Harms harmsd@sullcrom.com James C. Morphy morphyj@sullcrom.com Robert W. Reeder III reederr@sullcrom.com Glen T. Schleyer schleyerg@sullcrom.com Andrew D. Soussloff soussloffa@sullcrom.com Carlos J. Spinelli-Noseda spinellinosedac@sullcrom.com Donald C. Walkovik walkovikd@sullcrom.com Washington, D.C. Eric J. Kadel, Jr kadelej@sullcrom.com Robert S. Risoleo risoleor@sullcrom.com Dennis C. Sullivan sullivand@sullcrom.com -8-

9 Los Angeles Patrick S. Brown Frank H. Golay, Jr Alison S. Ressler Palo Alto Scott D. Miller John L. Savva London Kathryn A. Campbell Richard C. Morrissey John O'Connor William A. Plapinger David B. Rockwell Christine A. Spillane George H. White III Paris Nikolaos G. Andronikos William D. Torchiana Frankfurt Krystian Czerniecki David F. Morrison Melbourne John E. Estes Sydney Waldo D. Jones, Jr Tokyo Izumi Akai Hong Kong William Y. Chua Chun Wei John D. Young, Jr Beijing Robert Chu NY12525: