Analysis of New Reg D End of Solicitation Ban Rules: Parts I-III

Analysis of New Reg D End of Solicitation Ban Rules: Parts I-III

With unusual speed, the SEC released its proposed rules on ending the ban on general solicitation and advertising in Regulation D Rule 506 offerings to accredited investors yesterday, the same day as the SEC hearing on the subject. I have scoured pretty much all of it and thought I would jot down some highlights of the proposal in the next few posts that I didn't get to below. Here we go.

1. To clarify, securities issued under new proposed Rule 506(c) (where you can generally solicit) would be "restricted securities" subject to sale only under Rule 144 or registration.

2. Although they did not specify methods for confirming an investor's accredited status, they listed some examples of factors issuers should consider in making the determination. These are: (a) the nature of the purchaser and the type of accredited investor that the purchaser claims to be, (b) the amount and type of information that the issuer has about the purchaser and (c) the nature of the offeirng, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount. In the next entries we will get to these in more detail.

3. There is proposed to be a check box on Form D to be filed when doing a Reg D offering indicating that you are doing an offering under the new proposed 506(c) with general solicitation permitted.

4. They clarified that private funds can still benefit from the end of the ban on general solicitation in raising money for their fund without losing their right to be excluded from registering under the Investment Company Act.

In the SEC's proposed rules on ending the ban on general solicitation and advertising in Regulation D Rule 506 offerings to accredited investors, the SEC indicated that there are some factors to consider in determining whether the company has taken reasonable steps to verify that purchasers are all accredited, a condition to being allowed to do advertising and general solicitation. There are three main factors they outlined, we will take each in these next posts.

The first factor is the "nature of the purchaser and the type of accredited investor that the purchaser claims to be." Certain ways to be accredited are easily confirmable. For example, broker-dealers and investment companies registered with the SEC and FINRA are accredited. This is easy to verify online.

An individual can be accredited based on his income or net worth. The SEC acknowledged that there could be legitimate privacy concerns in asking someone to disclose personal financial information. Yes, it is relatively easy to ask someone for their most recent W-2 forms to verify income, but some people, rightfully so, would rather not do so. They took pains to make clear they are not specifying particular methods, just suggesting some factors to consider.

The SEC also reminded companies to make sure they maintain good records of what steps they took to verify accredited status, since case law makes clear that the burden would be on the company to show it was entitled to the exemption from SEC registration contained in Regulation D. This is very good advice.

One thing the SEC talked about was the possible development of "innovative approaches" to deal with verifying accredited status, including third-party clearinghouses or databases of accredited investors. This idea could make sense, if, say a broker-dealer allowed accredited investors to verify themselves somehow on a separate website, with confidentiality so that their specific information is not revealed to companies other than verification that the individual is accredited.

The next factor the SEC suggested we consider in determining whether a company has taken reasonable steps to verify an investor's accredited status is the amount and type of information that an issuer has about a purchaser. They start by suggesting that the more information someone has about an investor, the fewer additional steps need to be taken, which makes sense.

They add some useful suggestions on how to obtain information that could be helpful: for example, a named executive officer of the company is automatically accredited. If the company is public, this is easy to verify through the company's periodic SEC filings. In addition, some not-for-profit companies  are accredited if they have at least $5 million in assets. Every such company has to file Form 990 with the IRS and that is publicly available, so you can confirm their assets that way. As to individuals, they suggested that some industries have trade publications that provide information about the industry generally or even the investor's company as to what individuals at the investor's level earn on average.

Of course they also suggest that getting someone's W-2 form or having a broker-dealer, attorney or accountant confirm their status is also helpful, but, they warn, "provided that the issuer has a reasonable basis to rely on such third-party verification." Some feared this rulemaking would involve requiring this kind of third party verification, but they chose not to require any particular method, as indicated previously, because every situation is different.

For additional insights on reverse mergers, SPACs, other alternatives to traditional initial public offerings, the small and microcap markets and the economy, visit the Reverse Merger and SPAC Blog  by David N. Feldman, Esq., Partner of Richardson & Patel LLP.

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