SEC Adopts Major Amendments Affecting Private Placements of Securities

On July 10, the SEC adopted two major amendments affecting offerings under Rule 506 of Regulation D.  Rule 506 is used for most private placements, because there are no restrictions on the size of the offering and because it provides an offering exemption under federal law and all state securities laws.  The amendments will go into effect 60 days following publication in the Federal Register (i.e., in mid-September). 

The first amendment, which affects all Rule 506 offerings, is the adoption of so-called “bad boy” provisions, which preclude certain issuers from using Rule 506, if “covered persons” have suffered a “disqualifying event.”  The covered persons are the company issuing the securities, its predecessors, and its executive officers, directors, managing members, promoters, placement agents, etc.  The disqualifying events are convictions of securities felonies and misdemeanors, administrative orders from the SEC, CFTC or state securities, banking or insurance regulators relating to violations and other similar issues.  The disqualifying event must have happened in the last 5 years with respect to the issuer, and 10 years with respect to individuals.  Under the amendment, issuers will only be prohibited from using Rule 506 if the disqualifying event happened after the effective date of the amendment.  However, there is an obligation to disclose to all purchasers (both accredited and non-accredited) any event which occurred before the effective date which would otherwise be a disqualifying event.  Failure to disclose these matters will result in loss of the exemption.  ALL ISSUERS WHO HAVE AN ONGOING RULE 506 OFFERING MUST DETERMINE WHETHER ANY OF THESE DISQUALIFYING EVENTS EXIST AND MAKE THE REQUIRED DISCLOSURES TO ALL PURCHASERS AFTER THE EFFECTIVE DATE.

The second amendment gives issuers the option of advertising Rule 506 offerings.  Under current law, issuers are not permitted to use any general solicitation in connection with a Rule 506 offering.  Offerings consistent with current law, which do not include general solicitation and which may include up to 35 non-accredited investors meeting requirements as to sophistication, will still be permitted and will be called Rule 506(b) offerings.  When the amendment becomes effective, issuers may use general solicitation, such as newspaper and radio ads, as well as unrestricted web sites, to promote their offerings.  Offerings using general solicitation will be known as Rule 506(c) offerings.  However, all sales in Rule 506(c) offerings may be made only to accredited investors and the issuer is required to take “reasonable steps” to verify the accredited investor status. It is specifically not a defense that the person is actually an accredited investor if the issuer does not take “reasonable steps” to confirm the “accredited investor” status prior to the sale.  The SEC has not dictated what “reasonable steps” must be taken; however, they have made it clear that a “check-the-box” questionnaire (common under current Rule 506 offerings) is not sufficient.  Here is a list of steps which the SEC says will be sufficient for individual accredited investors:

• for accredited investors meeting the income test, reviewing  filed tax returns or other IRS forms such as W-2s or 1099s, as well as obtaining  written representations from the individuals;
• for accredited investors meeting the net worth test, certified copies of brokerage statements (for assets) and a commercial credit report (for liabilities), as well as obtaining written representations from the individuals;
• certification of accredited investor status by a broker, lawyer or accountant; and
• for an issuer's investors who had purchased as accredited investors prior to the effective date of the amendment, a self-certification of accredited investor status.

Companies which have an active Rule 506 offering, or are contemplating a Rule 506 offering, will need to decide whether they wish to use general solicitation and have an “all accredited” offering, subject to the new, more stringent verification requirements.