The SEC Liberalizes Reg D Financings: Not So Fast!

15 Aug
2013
By: Jessica R. Sudweeks

On July 10, 2013, the SEC released long awaited amendments to Regulation D to permit “general solicitation” and “general advertising” in private securities offerings, as mandated by the JOBS Act.   While much has been written about how new Rule 506(c) will make it easier to market a private placement to accredited investors, little has been said about the heightened due diligence issuers will be faced with in order to take advantage of the liberalized rules.

Rule 502 has prohibited issuers from advertising private placements since its adoption in 1982.  New Rule 506(c), which will become effective on September 23, 2013, permits issuers to use public advertising to offer unregistered securities to accredited investors, including both print and television ads, seminars, or even careful use of social media. However, to comply with the safe harbor offered by new Rule 506(c), issuers must “take reasonable steps to verify that the purchasers of the securities are accredited investors.” As is often the case with securities regulation, phrases like “reasonable steps” are not as simple to interpret in practice as they appear, and in the context of the liberalization of Regulation D offerings, the SEC will certainly be watching.

According to the SEC, an issuer should take reasonable steps to verify that each purchaser in a Rule 506(c) offering is, in fact, an accredited investor, by making “an objective determination” “in the context of the particular facts and circumstances of each purchaser and transaction.” The SEC describes this as a principles-based approach that provides “flexibility to adopt different approaches to verification, adapt to changing market practices, and to implement innovative approaches to meeting the verification requirement.” As if the SEC foresaw mass confusion and an influx of questions seeking to clarify such a vague standard, the SEC offered a non-exclusive list of methods that will satisfy Rule 506(c)’s verification requirement.

The SEC’s non-exclusive list is separated into different methods, depending how each purchaser meets the accredited investor standard. For those purchasers that qualify by annual income ($200,000 for individuals, $300,000 for married couples), an issuer may review any IRS form that reports income.  A purchaser claims to be an accredited investor based on net worth? An issuer may meet Rule 506(c)’s verification requirement by: (i) verifying the purchaser’s assets by reviewing a bank statements, brokerage statements, or other statements of securities holdings, certificates of deposit, tax assessments, or appraisal reports issued by independent third parties; (ii) a written disclosure from the purchaser listing all liabilities necessary to make a determination of net worth; and (iii) obtaining a consumer credit report to verify the accuracy of the purchaser’s disclosure of liabilities. In a departure from the SEC’s air of flexibility and attempts to only offer context, the SEC will require any issuer accepting purchasers who are accredited investors based on net worth to obtain “a consumer credit report and a written representation from such person that all liabilities necessary to make a determination of net worth have been disclosed.”

The release adopting Rule 506(c) attempts to reassure issuers that the verification requirement is a flexible standard, and the offering of a non-exclusive list of methods that satisfy the condition only seeks to offer context to an otherwise vague requirement. However, it is in this list of methods that Rule 506(c) stops looking like a viable tool to expand an issuer’s ability to raise capital, and begins to resemble a pitfall for unsuspecting issuers.  One of the easiest ways to avoid the pitfalls associated with verification is to simply limit participation in private placements to existing investors.  As adopted, Rule 506(c) provides that any person who invested in an issuer’s prior 506 offerings and remains an investor of the issuer is deemed to satisfy the verification requirement.

As is currently the case in most private placements, issuers rely on the placement agent’s vetting process to determine whether a purchaser is “accredited” long before the purchaser signs an accredited investor questionnaire.  Issuer’s may continue to rely on the placement agent, provided it obtains a written verification of a purchaser’s accredited investor status from the placement agent, and so long as the placement agent or other third-party has taken reasonable steps to verify the purchaser’s status.  The SEC has given notice that the execution of an accredited investor questionnaire without any further verification will no longer be sufficient:

We do not believe that an issuer will have taken reasonable steps to verify accredited investor status if it, or those acting on its behalf, required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status.”

At the end of the day, we will not fully understand the impact of Rule 506(c)’s verification requirement until we begin to see how issuers and their counsel respond to the new Rule.  The SEC will be evaluating the development of market practices, and their efforts in this regard will be enhanced in the event further proposed amendments to Regulation D are adopted. These additional proposed amendments are currently out for public comment, and include, among others, requiring disclosure in Form D of the steps taken by an issuer to verify that each purchaser in a Rule 506 offering is an accredited investor.  In fact, the SEC goes one step further and proposes a one-year disqualification from using Rule 506 to make private offerings if an issuer fails to comply with the Form D filing requirement.

Bottom line: issuers are cautioned against conducting advertising and marketing campaigns designed to reach accredited investors with whom the issuer does not have a preexisting relationship, and relying on old accredited investor questionnaires without some affirmative step to qualify investors in Rule 506 offerings.  We intend to carefully monitor the SEC’s pronouncements, and will update The Public Company Report when further guidance is warranted.

 

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One Response to “The SEC Liberalizes Reg D Financings: Not So Fast!”

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  1. The JOBS Act: General Solicitation Rules changes | Wyly Wade - August 16, 2013

    […] The SEC Liberalizes Reg D Financings: Not So Fast! […]

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