News & Features

SEC Finalizes Rules to Permit Advertising in Regulation D Private Placements

by Robert T. Smith, Sean Evans, John F. Griffee, and Conner McNair As we reported last fall, the U.S. Securities and Exchange Commission (SEC) previously issued a proposed rule pursuant to the Jumpstart Our Business Startups (JOBS) Act (H.R. 3606) to implement amendments to Rule 506 of Regulation D. The proposed rule was finalized last week (the Final Rule) to allow issuers to conduct public advertising in connection with an offering pursuant to Rule 506. This is obviously a fundamental change in how private placements are conducted and should have a major impact on capital raising opportunities. Accompanying the change was a final rule to allow the SEC to ban certain bad actors from participating in Rule 506 offerings. Additionally, the SEC proposed new rules to require additional disclosures in Rule 506 offerings. The Final Rule becomes effective 60-days after publication in the Federal Register. General Solicitation in Rule 506 Offerings Rule 506 is the most commonly used federal securities exemption for issuers raising capital. Typically the main drawback to using Rule 506 is the restriction prohibiting the issuer from engaging in any form of public advertising or solicitation. This has resulted in the development of a general rule of thumb that investors have some substantive pre-existing relationship with the issuer (or its representatives) in order to participate. The Final Rule completely removes the prohibition on advertising if the requirements of new Rule 506(c) are satisfied.1 These requirements include:

1. the issuer must take reasonable steps to verify that all purchasers of the securities are accredited investors;
2. all purchasers of securities must be accredited investors. The comments to the Final Rule clarify that this requirement is not absolute, and may be met provided the issuer has a reasonable belief that each investor is accredited;
3. the issuer must file a Form D indicating whether it is relying on Rule 506(b) or 506(c); and
4. all other terms and conditions of Rule 501 and Rules 502(a) (integration) and 502(d) (limitations on resale) must be satisfied.

Reasonable Steps to Verify Purchasers are Accredited The JOBS Act mandates that amendments to Rule 506 require issuers using general solicitation in Rule 506 offerings to take reasonable steps to verify that purchasers of the securities are accredited investors. In its proposed rule, the SEC did little to clarify specific methods by which issuers could verify accredited status. This was a repeated criticism in comments to the proposal, and the Final Rule contains a non-exclusive list of methods that may be used to satisfy the verification requirement:

1. reviewing statements, such as IRS forms and return, that evidence sufficient income of the investor and obtaining written representations that he/she will likely continue to earn the necessary level of income in the current year;
2. reviewing statements that evidence sufficient net worth, such as bank statements and a consumer report from a nationwide consumer reporting agency; and
3. receiving written confirmation from a registered broker-dealer, investment advisor, licensed attorney or CPA that it has taken reasonable steps to verify the purchasers accredited status.

The methods listed in the SECs non-exclusive list are deemed to satisfy the reasonable verification requirement. Prohibiting Participation by Bad Actors The Final Rule finalized a proposal to disqualify any attempted reliance on Rule 506 by persons who have been subject to any conviction, injunction, court order or similar proceeding involving violations of securities laws and similar provisions. The bar can apply based on prior conduct going back up to 10-years prior to the date of the proposed offering, however, the Final Rule may be enforced only with respect to conduct following the effective date. Even though the SEC ultimately decided against imposing disqualification for pre-existing conduct, the Commission will require disclosure to investors regarding pre-existing conduct that would have triggered disqualification, but for the fact that it occurred before the effective date of the Final Rule. Related Proposals The Commission also issued for public comment other measures intended to address investor concerns. These proposals include the following:

1. amendments to Rule 503 to require issuers intending to use public advertising to file Form D with the SEC at least 15-days prior to any general solicitation;
2. requiring an issuer to file a final amendment to Form D no more than 30-days after termination of a Reg D offering;
3. amendment to Rule 507 disqualifying an issuer from future reliance on Rule 506(c) if the issuer failed to file a Form D in a prior Rule 506 offering;
4. proposed adoption of Rule 509 that would require specific restrictive legend disclosures on all Rule 506(c) offering materials, and additional disclosure requirements for advertising materials used by private funds; and
5. temporarily requiring that all issuers using Rule 506(c) submit their disclosure and advertising documents to the SEC no later than the date of first use.

Observation While the Final Rule opens many possibilities with the use of new Rule 506(c), it is important to note that the rule actually bifurcates Rule 506 into two separate exemptions: (i) the tradition Rule 506 exemption (Quiet 506); and (ii) a new exemption under Rule 506(c) under which public advertising is permitted (Loud 506). Whether an issuer will rely on a Quiet or Loud 506 exemption will depend on the circumstances of the offering and the issuers need for widespread marketing to raise funds. The debate over the adequacy of investor protections will likely continue without any end in sight. The proposals mentioned above, along with the Commission directing its staff to closely monitor use of advertising in Rule 506 offerings, indicate that the concerns of vocal opponents to rule will not soon be resolved. We regularly assist both financial and non-financial clients in capital raising activities, including compliance with federal and state exemption requirements. Please contact one of the attorneys listed above if you have any questions or would like to discuss any of the topics discussed in this publication. This Friday, Eldredge & Clark, LLP publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney on any specific legal questions you may have.

1. The Final Rule leaves intact the original Rule 506 exemption, designated as a Rule 506(b) offering.