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BY JAY G. BARIS, DAVID M. LYNN & ANNA T. PINEDO, MORRISON FOERSTER --
On July 10, 2013, U.S. Securities and Exchange Commission staff held an open webcast of a hearing during which it announced changes in rules relating to the Jumpstart Our Business Startups Act, or the JOBS Act. Below is a report quickly posted about the hearing by Morrison Foerster’s Baris, Lynn and Pinedo on the day of the hearing, with additional text provided by Pinedo for the Advisory. The recording of the webcast is still available at SEC.gov. Click on the image and it will take you there.
Also, the JOBS Act will be the subject of a LexisNexis seminar taking place in Chicago on Sept. 25, where Anna Pinedo will be one of the featured speakers. Click HERE to learn more about this complimentary CLE program.
July 10, 2013, At long last, the U.S. Securities and Exchange Commission (SEC) took action to implement rules that complied with the JOBS Act mandate to relax the prohibition against general solicitation in certain private offerings of securities. The original SEC proposal from August 2012, proposing amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act, had drawn significant comments.
The final rule, as well as the SEC’s proposed rules relating to private offerings discussed below, are likely to generate additional commentary. One might say that this morning’s webcast of the SEC’s open meeting provided a glimpse into the too-hot/too-cold Goldilocks-type debate that will continue to play out over the next few months regarding the appropriate balance between measures that facilitate capital formation and investor protection provisions.
In addition to promulgating rules to relax the ban on general solicitation, which will have a significant market impact, the SEC also adopted the bad actor provisions for Rule 506 offerings that it was required to implement pursuant to the Dodd-Frank Act. The bad actor proposal had been released in 2011, and SEC action had been anticipated on the bad actor proposal for some time. The SEC also approved a series of proposals relating to private offerings that are intended to safeguard investors in the new world of general advertising and general solicitation.
All told, will these measures encourage or discourage issuers and their financial intermediaries from availing themselves of the opportunity to use general solicitation? Will this new ability to reach investors with whom neither the issuer nor its intermediary have a pre-existing relationship create serious investor protection concerns? Will the proposed investor protection measures be sufficient to address the concerns of consumer and investor advocacy groups, or will we ultimately see revamped investor accreditation standards?
Below we provide a very brief summary of the morning’s actions. [excerpts only]
SEC Adopts Amendments to Rule 506
The SEC adopted amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act to implement Section 201(a) of the JOBS Act. The SEC adopted new paragraph (c) in Rule 506, which would permit the use of general solicitation and general advertising, subject to the following conditions:
• the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors;
• all purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they qualify as accredited investors, at the time of the sale of the securities; and
• the conditions of Rule 501 and Rules 502(a) and 502(d) are satisfied.
The Staff indicated that “reasonable efforts” to verify investor status will be an objective determination by the issuer based on the SEC’s principles-based guidance. In its proposed rules, the SEC had noted that “reasonable efforts” to verify investor status should consider the nature of the purchaser; the nature and amount of information about the purchaser; and the nature of the offering.
In a departure from the proposed rules, the final rule will provide a non-exclusive list of factors to consider in verifying the accredited investor status of natural persons. Following the initial proposal, many commenters had advocated that a “safe harbor” be established to establish legal certainty that the verification process had been sufficiently robust. Including this illustrative list as part of the rule will likely prove helpful, even if it does not go as far as some commenters had requested.
In addition to the changes adopted to Rule 506, the SEC amended Rule 144A to eliminate references to “offer” and “offeree,” and as a result Rule 144A will require only that the securities are sold to a Qualified Institutional Buyer (QIB) or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under this amendment, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are limited in this manner.
Commissioner Luis Aguilar strongly opposed the new rules, saying he was “saddened and disappointed” that the new rules did not do more to protect investors.
Bad Actor Rule Proposal
In the same meeting, the SEC explained that it was adopting the bad actor rule in substantially the form in which it was proposed in May 2011 with certain modifications. The Staff explained that the rule contains modifications to the categories of persons covered; modifications to the types of actions that are covered; and modifications to the actions that are covered.
In addressing the modifications to the categories of “covered persons,” the Staff explained that, in certain respects, the categories were being narrowed. For example, the Staff noted that, as
opposed to covering all officers of the issuer, the rule will cover executive officers and officers involved with the proposed offering. The rule will cover beneficial owners of 20% or more of an issuer’s total shares outstanding. The Staff noted that investment managers of funds and the principals of such investment managers will be added as covered persons.
The Staff noted that the types of actions covered in the final rule (“disqualifying events”) have been modified from the proposal in order to include certain SEC cease-and-desist orders related to violations of anti-fraud provisions and registration requirements, and to add the CFTC to the list of agencies whose final orders trigger the application of the bad actor rules.
The rule also will address one of the most controversial provisions of the proposal, which is the timing of an action that triggers the application of the bad actor provisions. The rule will provide for disqualification only in respect of triggering bad acts that occurred after the effective date of the rule, however, triggering events that occurred prior to the effective date of the rules will need to be disclosed to investors.
Investor Protection and Information Requirements Proposed
The SEC is proposing rules for comment that will impose a number of investor protection measures in connection with Rule 506(c) offerings. These include the following: A proposed amendment to Rule 503 in order to implement additional compliance requirements relating to the filing of a Form D. In connection with a Rule 506(c) offering, an issuer will be required to file a Form D not later than 15 calendar days from the commencement of general solicitation efforts. In addition, in order to provide the SEC with more information regarding these types of offerings, the issuer will be required to file a final amendment to the Form D within 30 days after the completion of such an offering.
Along the same lines, in order to make additional information available to the SEC, the proposal would revise Form D in order to request additional information in the context of Rule 506(c) offerings. For example, the amended Form would require additional information about the issuer, the offered securities, the use of proceeds of the offering, the types of general solicitation that were used, and the methods used to verify investor status.
Rule 156 Proposal
The SEC proposed to require private funds making Rule 506(c) offerings to file written general solicitation materials with the SEC on a temporary basis. The filings would be required to apply for a period of two years, and would not be available to the public. The SEC also proposed to amend Rule 156 under the Securities Act of 1933, the anti-fraud rule that applies to sales literature of registered investment companies.
Rule 156 provides a non-exclusive list of factors concerning representations of past or future investment performance that could be misleading. It also contains examples of when statements about possible benefits connected with or resulting from the services to be provided that do not give equal prominence to discussion of any associated risks.
Rule 156 broadly defines “sales literature,” which generally means any communication (whether in writing, by radio or by television) used to sell or induce the sale of securities of any investment company.
Below, Morrison Foerster’s Anna Pinedo provided additional guidance for this issue of The Advisory.
Issuers and their counsel will want to consider closely the new flexibility that will be available for private offerings. In certain instances, the ability to engage in general solicitation, while attractive, may not be sufficiently compelling. For example, from time to time, an issuer that is already a public company may decide to raise capital through a private placement, or PIPE, transaction. Typically, an already public company that chooses to undertake a PIPE transaction would like to keep information about the potential financing confidential and not be required to make any premature public announcement. A public announcement will only be made once the issuer has entered into definitive agreements with investors.
General solicitation is unlikely to be used by already public companies in their private offerings.
For a privately held company that has engaged in several rounds of financing and has existing relationships with private equity or venture investors and/or with investment banks, the advantages associated with general solicitation may not outweigh the costs. The company may find it most efficient to conduct follow-on or subsequent financing rounds in reliance on Rule 506(b), without general solicitation.
For those issuers that are at an earlier stage of their development, the prospect of being able to reach a broader audience may be compelling.
Any issuer that is considering using general solicitation will want to think carefully about formulating a communications policy pursuant to which it outlines who is authorized to speak on the issuer’s behalf, the review or vetting process for any statements made about the issuer, and the timing and medium for such communications. An issuer remains liable for any statements it makes or authorizes others to make on its behalf. As a result, an issuer will want to take care to ensure that it controls the solicitation process or, if it is working with a financial intermediary, that it coordinates any solicitation process closely.
The issuer also will want to consider whether it has the compliance infrastructure necessary to undertake the investor verification process, or whether it will instead rely on a financial intermediary or a third-party verification service. If it relies on a third-party, the issuer will still have to undertake some diligence regarding the process used to verify investor status so that it can establish a basis for its reliance on the service provider.
Certain issuers, such as funds advised by entities that are registered investment advisers, or funds that are commodity pools, will be subject to limitations and requirements relating to the content of any written general solicitation materials.
Similarly, registered broker-dealers that engage in general solicitation on behalf of their issuer clients also are subject to extensive requirements relating to the content of their communications.
In advance of the September 23 effective date for the new rules, issuers, broker-dealers and their advisers should formulate policies and procedures, as well as new documentation, which will address the use of general solicitation in private offerings and the final bad actor rules.
Disclaimer: The views and opinions expressed in this article are those of the individual sources referenced and do not reflect the views, opinions or policies of the organizations the sources represent.