On November 13, 2013, the SEC released new compliance and disclosure interpretations (which we’re calling FAQs) aimed at addressing common questions relating to private offerings that make use of general solicitation under new Rule 506(c) and Rule 144A.
Rule 144A / Regulation S Clarifications
Regulation S provides an exemption for offers and sales of securities outside the United States. One condition to Regulation S is “no directed selling efforts are made in the United States by the issuer, a distributor, any of their respective affiliates, or any person acting on behalf of any of the foregoing.” Directed selling efforts are defined to be any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered in reliance on this Regulation S. Such activity includes placing an advertisement in a publication “with a general circulation in the United States” that refers to the offering of securities being made in reliance upon this Regulation S. The new FAQs clarify that:
- In a Rule 144A offering in which securities were sold to financial intermediaries in exempt transactions pursuant to Section 4(a)(2) or Regulation S, general solicitation may be conducted by the initial purchasers in the Section 4(a)(2) or Regulation S transactions as well as by the issuer.
- Rule 144A offerings are often conducted in tandem with Regulation S offerings. According to the FAQs the amendments to Rule 144A permitting the use of general solicitation do not change how directed selling efforts under Regulation S are analyzed in concurrent Rule 144A and Regulation S offerings.
Issuer Verification Methods and Conclusions Trump Actual Circumstances
- When it comes to the status of purchasers as accredited investors, the Rule 506(c) exemption hinges on whether the issuer took reasonable steps to verify the accredited investor status of purchasers and formed a reasonable belief that the purchasers met that standard, rather than whether the purchasers are actually accredited investors. If a purchaser turns out to not, in fact, be an accredited investor, the Rule 506(c) exemption is still valid as long as the issuer made a reasonable inquiry and formed a reasonable belief as to the purchaser’s accredited status within the meaning of Rule 506(c). Conversely, if an issuer fails to make the necessary inquiry, the Rule 506(c) exemption will not be available to the issuer, even if it turns out that each purchaser is in fact an accredited investor.
Clarifications Regarding the Non-Exclusive Safe Harbors for Verification
- Rule 506(c) provides a non-exclusive list of four methods of verifying accredited investor status that will be deemed reasonable under the rule. The SEC makes a distinction between relying on one of these enumerated safe harbors and relying on the general principles-based approach of Rule 506(c), in which the question of whether an inquiry was reasonable depends on evaluation of all of the facts and circumstances. For example, if an issuer is relying on the review of financial records method for verifying accredited investor status, but, at the time of the purchase of securities, the financial records the issuer reviewed are older than 3 months, the issuer will be unable to rely on the financial records method and will instead need to fall back on the principles-based general approach.
- The verification method that relies on written certification by attorneys or other licensed professionals does not require that the professional be licensed in the U.S.
- The safe harbor for existing investors in the issuer does not extend to affiliates of the issuer or common sponsors; if NewCo and OldCo are both sponsored by Investment Fund, a purchaser of NewCo securities will not fall within the existing investor safe harbor by reason of being an existing investor in OldCo.
Issuers Can Convert Ongoing Traditional Private Offerings to Rule 506(c) Offerings
- If an issuer sets out to conduct a Rule 506(b) offering may subsequently determine to change the offering to take advantage of Rule 506(c) and general solicitation. The key question is whether all of the requirements of Rule 506(c) are met with respect to all sales in the offering – including sales made prior to the determination to transition to a Rule 506(c) offering. If the issuer filed a Form D before undertaking general solicitation, that Form D would need to be amended to indicate that the issuer was relying on Rule 506(c). This same concept applies in the case of an issuer that began a Rule 506 offering before new Rule 506(c) went effective in September and wants to transition to a generally solicited offering.
Issuers May Be Unable to Fall Back on Section 4(a)(2)
- In a traditional Rule 506 offering (now a Rule 506(b) offering), the exemption in Section 4(a)(2) of the Securities Act provided a safety net of sorts; even if an issuer blew the 506 exemption by failing to comply with a specific requirement of the rule, the issuer could always fall back on the exemption provided in Section 4(a)(2). In a Rule 506(c) offering, this may not be the case. If an issuer attempts to comply with Rule 506(c) but fails to fulfill the requirements of the rule, the Section 4(a)(2) exemption will not be available to the issuer if the issuer has conducted general solicitation in connection with the offering.
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