Today is September 23, 2013, the day that the SEC rules flowing from Title II of the JOBS Act regarding general solicitation become effective.
The Old Rules
Until today, issuers of securities who claimed an exemption from registration under Rule 506 of Regulation D were prohibited from generally soliciting or advertising sales of their securities. Since a Rule 506 offering is a “private” placement, it makes sense that general advertising or solicitation would negate the private nature of the offering and would therefore not be permitted. However, in order to remove a potential barrier to investment, Title II of the Jobs Act has since amended Section 4 of the Securities Act of 1933 to state that offers and sales exempt under Rule 506 shall not be deemed public offerings as a result of general advertising or general solicitation. (You can read the Jumpstart Our Business Startups Act, or JOBS Act, in its original form here.)
In practice, this means that, prior to today, an issuer of securities under a Rule 506 exemption could only solicit accredited investors with whom it had a preexisting relationship. Alternatively, the issuer could engage a broker-dealer, thereby opening the pool to those accredited investors in the broker’s circle. So take, for example, equity crowdfunding websites (here, we are talking about sites that offer a real investment stake in a business in exchange for a capital contribution rather than companies that might give “investors” a free t-shirt or similar reward in exchange for a smaller contribution). Up until today, these sites have only permitted an issuer’s detailed business plan or “pitch” to sell securities to be seen by accredited investors, who must must first register and log in to the website to gain this level of access. This way, the website could not be accused of making a “general solicitation,” as it surely would be if it advertised the sale of securities on the internet to the general public. Here are examples of these websites’ policies: http://www.fundable.com/faq/how-investors-user-fundable; and https://rockthepost.com/faq… Note: by the time you click these links general solicitation will be permitted, and these sites may have changed their policy, so here are some screen shots from pre-September 23, 2013, to give you an idea what kind of advertising restrictions were in place (click on each one for a larger view):
The New Rules
The newly-effective SEC final rules now permit an issuer to engage in general solicitation or advertising in offering securities pursuant to Rule 506, provided that (i) the issuer is not a “bad actor” who has had previous ‘troubles’ with securities laws, (ii) all purchasers of the security are accredited investors, and (iii) the issuer takes reasonable steps to verify that such purchasers are accredited investors. (You can read a summary of the rule here, and the full rule here). This means that Pat’s Pizza, a hypothetical small business with a fledgling 3 stores looking to grow can let the world know on its Facebook page, “Pat’s is growing and looking for investors!!” The catch, however, is that Pat’s still can only accept investments from accredited investors. Moreover, Pat’s must now take additional steps to verify that an investor is in fact accredited, whereas formerly accredited investors were self-identified.
The means of verifying accredited investor status was one of the main tasks for the SEC in issuing rules pursuant to Title II of the Jobs Act. The newly-effective rules are codified in Rule 506(c). There is no mandatory or exclusive method of verifying accredited investor status, but the issuer is required to consider the facts and circumstances of each purchaser. Although there is no exclusive list of verification methods, the SEC has identified a couple of ways an issuer may comply; for example, by reviewing copies of the investor’s tax returns and having the investor verify his/her income in the coming year, or by receiving a written confirmation from a registered broker-dealer, attorney, or CPA stating that such person has taken reasonable steps to verify the purchaser’s accredited status.
As a note, if an issuer wishes to solicit or advertise only to accredited investors and chooses not to generally advertise, the issuer is not then required to verify accredited investor status, and accredited investors can be self-identifying, the rules essentially operating just as they did prior to Title II.
To add just one more layer, on the same date the SEC issued final rules regarding general solicitation, it issued proposed rules that would require the issuer to disclose information about itself prior to general solicitation (currently, issuers claiming exemption under Rule 506 of Regulation D must file a fairly simple form with the SEC, called Form D, within 15 calendar days after the first sale of securities in the offering). In addition, the proposed rules would require the filing of a closing amendment to Form D after the termination of a Rule 506 offering, would require general solicitation materials to include certain legends and other disclosures, and would require submission of general solicitation materials to the SEC. Many people have submitted comments to the SEC requesting that no new rules be enacted to make the process overly cumbersome. How this next round will play out remains to be seen.
In practice, even though issuers relying on a 506 exemption can now advertise (subject to the restrictions outlined above), even to include social networking sites, such promotion must still lead back to a platform where the issuer can verify accredited investors prior to sale. Arguably, then, an issuer should still advertise where it is likely to find accredited investors, because ultimately it cannot sell to non-accredited investors, at least for now. Title III of the Jobs Act does permit crowdfunding from non-accredited investors, however, unlike Title II, the new SEC rules have not yet been enacted (see PayPal and crowdfunding: fools rush in… but the rest of us are still waiting). More on crowdfunding in a forthcoming post.
This is, of course, a complex area of law, and the above summary does no more than introduce the general concepts and developments involved in a small part of it. If you are contemplating any sort of private placement, speak to a securities lawyer at Briskin Cross & Sanford before you do anything… and certainly before you post your offering on Facebook!