The SEC Eliminates the Prohibition Against General Solicitation and General Advertising in Rule 506 Offerings

July 16, 2013

On July 10, 2013, the Securities and Exchange Commission (“SEC”) approved an amendment to Rule 506 of Regulation D permitting an issuer to engage in general solicitation or general advertising in their offering and selling of securities pursuant to Rule 506. Under new Rule 506(c), issuers can engage in such advertising and solicitation provided that all purchasers of the securities are “accredited investors” and the issuer takes “reasonable steps” to verify that such purchasers are accredited investors.  The SEC adopted the amendment to implement changes mandated by Section 201(a) of the Jumpstart Our Business Startups Act (the “JOBS Act”).

The new Rule should be welcome news for any issuer seeking to raise capital. Issuers will now be able to use a number of previously unavailable methods to advertise their offering of securities and reach a greater number of potential investors. However, issuers will need to be particularly careful to adhere to the requirements of the new Rule to avoid conducting an unregistered public offering.

The amendment includes a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons. In addition, in a separate release, the SEC also adopted rules disqualifying felons and other “bad actors” from participating in Rule 506 offerings.

The new Rule will take effect 60 days after its publication in the Federal Register.

New Rule 506(c)

Under new Rule 506(c), issuers can offer securities through means of general solicitation and general advertising provided that (1) all purchasers of securities are accredited investors, (2) the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors, and (3) all requirements of Rule 501 and Rules 502(a) and 502(d) are satisfied.

Reasonable Steps to Verify Accredited Investor Status

Under this new Rule, an issuer must take reasonable steps to verify that each purchaser is an accredited investor. Whether the issuer’s verification steps are reasonable depends on the facts and circumstances. However, the SEC did suggest some factors the issuer should consider when evaluating whether their verification steps are reasonable. These factors include (1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be, (2) the amount and type of information that the issuer has about the purchaser, and (3) the nature of the offering and the terms of the offering.

The new Rule also includes four non-exclusive methods of verifying accredited investor status for natural persons. These methods include:

  • when verifying whether a person meets the accredited investor income test, reviewing certain IRS forms and obtaining a written representation from the individual;
  • when verifying whether a person meets the accredited investor net worth test, reviewing certain bank statements, brokerage statements, appraisal reports, credit reports, and similar documents and obtaining a written representation from the individual;
  • a written confirmation from a registered broker-dealer, an SEC registered investment adviser, a licensed attorney, or certified public accountant that such person or entity has taken reasonable steps to verify that the investor is accredited within the prior three months; and
  • a certification of accreditation by any individual who participated in an issuer’s Rule 506(b) offering prior to the effective date of this new Rule and remains an investor of the issuer.

Form D Amendment

An issuer that utilizes the new Rule will be required to disclose such reliance in its Form D filing. A new check box for issuers relying on Rule 506(c) will be added to Form D pursuant to the amendment.

Bad Actor Disqualification Under Rule 506(d)

In a separate release on July 10, 2013, the SEC adopted new Rule 506(d) that disqualifies a securities offering from relying on Rule 506 if certain “covered persons” are felons or other “bad actors.”

Under the new Rule, an issuer will not be able to rely on Rule 506 if certain individuals or entities (including directors, officers, and beneficial owners of 20% or more of the voting securities of the issuer) have been subject to a disqualifying event. Examples of disqualifying events include (1) felony and misdemeanor convictions within the past ten years in connection with the purchase or sale of a security or involving the making of a false filing with the SEC, (2) court orders, judgments or decrees within the last five years restraining the person from engaging in or continuing conduct in connection with the purchase or sale of securities or involving the making of a false filing with the SEC, (3) final orders from certain state and federal agencies based on a violation of any law that prohibits fraudulent, manipulative, or deceptive conduct within the past ten years, (4) certain orders issued by the SEC, or (5) suspension or expulsion from membership in a registered national securities exchange or national securities association.

Disqualification events that occurred prior to the effectiveness of the new Rule will not trigger disqualification, but will be subject to mandatory disclosure.