Investment advisers must wait longer for relief from long-standing prohibitions
against general solicitation.
The Jumpstart Our Business Startups (JOBS) Act has mandated the Securities and Exchange Commission (SEC) to remove prohibitions against solicitation of the general public in connection with private placements of securities under the Securities Act of 1933 (Securities Act). At its Open Committee Meeting held on August 29, 2012, the SEC proposed rules to allow general solicitation and general advertising in connection with offers of securities under two rules, namely Rule 506 of Regulation D and Rule 144A.
When raising capital, hedge funds and privately offered funds typically rely on Section 4(a)(2) of the Securities Act which exempts certain transactions by an issuer not involving a public offering. Rule 506 under Section 4(a)(2) provides a safe harbor allowing issuers to offer and sell securities to an unlimited number of “accredited investors” as long as the issuer does not use any form of general solicitation (which includes advertising in newspapers and magazines, via television and radio broadcasts, at seminars whose participants have been invited by general solicitation, and through websites and social media).
Rule 144A is a safe harbor from the Securities Act’s registration requirements for re-sale of restricted securities (i.e. securities acquired in a transaction not involving a public offering) to Qualified Institutional Buyers (QIBs), which are generally investors with at least $100 million in assets. Offers of securities under Rule 144A currently must be limited to QIBs, effectively prohibiting offerings via a general solicitation.
Under the proposed Rule 506(c), issuers of securities will be permitted to use general solicitation to offer securities, provided that:
- the issuer takes “reasonable steps to verify” that the purchasers of the securities are accredited investors, defined as individuals with a net worth of at least $1 million (excluding the value of their primary residence), or annual income exceeding $200,000 ($300,000 with a spouse) in the two most recent years, and a reasonable expectation of the same income level in the current year; and
- all ultimate purchasers of securities are accredited investors.
The SEC took a flexible approach, stating that whether the verification steps are reasonable will be an objective determination based on the facts and circumstances of each transaction. Issuers should consider a number of factors when determining reasonableness, including the type of purchaser, the amount, and the type and nature of the offering. The SEC indicated that it would be impractical and potentially harmful to require issuers to follow uniform verification methods, as each circumstance may warrant review of different factors.
Although generally solicited private offerings will be exempt from registration requirements, SEC registered investment advisers shall remain subject to the general anti-fraud provisions under Section 206 of the Investment Advisers Act of 1940 with respect to offering materials used in connection with private offerings.
Under the proposed rules relating to Rule 144A, securities sold pursuant to Rule 144A could be offered to persons other than QIBs, including by means of general solicitation, provided that the securities are ultimately sold only to persons whom the seller reasonably believes are QIBs.
The SEC indicated that privately offered funds relying on the exclusion from the definition of “investment company” under Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 will be permitted to make a general solicitation under Rule 506(c) without losing either of those exclusions.
The SEC is seeking public comment on the proposed rules and shortly thereafter will determine whether to adopt the proposed rules. The estimated timing for the final rules varies, with some projecting that they will be finalized as early as this fall, while others are projecting that it may take until next year.