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From Securities Regulation Daily, July 10, 2013

SEC lifts ban on general solicitations in private offerings

By Jacquelyn Lumb

The SEC commissioners, in a split vote, adopted a rule to eliminate the ban on general solicitation and general advertising in Rule 506 offerings. The vote was also split on the issuance of a proposal to provide additional protections to investors in private offerings. Commissioner Luis Aguilar opposed the rule lifting the ban on general solicitation because it does not offer sufficient investor protections, in his view. Commissioners Troy Paredes and Daniel Gallagher opposed the proposed amendments to the private offering rules because of the new regulatory burdens they would impose. In their view, the new requirements would thwart the objectives of the JOBS Act. The commissioners voted unanimously to adopt a rule to disqualify felons and other bad actors from participating in Rule 506 securities offerings.

White’s remarks. In opening remarks, SEC Chairman Mary Jo White reviewed the current provisions of Regulation D Rule 506 offerings through which companies can raise an unlimited amount of money in a private offering, but may only sell their securities to accredited investors and are restricted in the way they solicit investors. The JOBS Act mandated that the SEC eliminate the ban on general solicitation in Rule 506 offerings to facilitate capital formation and encourage job creation. In response to the SEC’s August 2012 proposal, many commenters raised concerns about the increased potential for fraud once the ban is lifted.

Chairman White noted that some commenters questioned whether the SEC should defer lifting the general solicitation ban until it adopts more comprehensive investor protections. However, given the explicit language in the JOBS Act and the statutory deadline that passed last July, she stated the SEC should act without further delay. She said the SEC should closely monitor and collect data on the new market to determine the extent to which the changes have led to additional fraud. White said she is committed to keeping the investor protection proposal on track so the SEC can respond to the operation of the new rule and the comments that are received.

Lifting the ban on general solicitation. The changes to Rule 506 will permit issuers to use general solicitation and general advertising to offer their securities as long as they take reasonable steps to verify that the investors are accredited investors. The reasonableness of that determination will be based on an objective assessment by the issuer. The rule includes a non-exclusive list of methods that investors may use to satisfy the verification requirement, as requested during the comment period.

The methods include reviewing IRS forms that disclose the purchaser’s income, or receiving written confirmation from a registered broker-dealer, investment adviser, licensed attorney, or certified public accountant stating that reasonable steps were taken to verify the purchaser’s accredited status. Issuers that conduct Rule 506 offerings without the use of general solicitation or advertising may continue to conduct their offerings in the same manner as before and will not be subject to the verification rule.

Securities that are sold pursuant to Rule 144A could be offered to persons other than qualified institutional buyers (QIBs) by means of general solicitation as long as the securities are sold only to persons whom the seller and anyone acting on the seller’s behalf reasonably believe to be QIBs.

Form D was revised to include a separate box for issuers to check if they are relying on the Rule 506 exemption that permits general solicitation and advertising.

Walter’s support. Commissioner Elisse Walter noted that the removal of the ban on general solicitation will fundamentally change the market and will make increased vigilance even more important. She said it is important that the bad actor provisions are in place when the general solicitation ban is lifted. The investor protections in the rule proposal are important, she added, and the SEC should take final action as soon as practicable.

Aguilar’s dissent. Aguilar said he will post a more extensive outline of his opposition to the rule adoption on the SEC’s website, but, in his view, it comes at the expense of investors. Nothing in the JOBS Act removed the SEC’s broad authority in implementing the rule, he said; its hands were not tied. Many commenters expressed concern about the lifting of the ban, including the SEC’s own Investor Advisory Committee, he said, but they were ignored. The benefits from the investor-protection proposal will come much too late to protect investors, in his view. Aguilar said he was disappointed by the reckless adoption of the amendments to Rule 506.

The amendments will become effective 60 days after publication in the Federal Register.

Bad actor disqualification. Section 926 of the Dodd-Frank Act requires the SEC to adopt rules to prohibit the use of the Rule 506 exemption for any securities offerings in which certain felons or other bad actors are involved. The new rules were to be substantially similar to those found in Regulation A. The final rule adopted today would prohibit an issuer from relying on the Rule 506 exemption if it or any other person covered by the rule has a disqualifying event. The disqualification rule covers the issuer, its predecessors, and affiliated issuers.

Other covered persons include: directors, certain officers, general partners, and managing members of the issuer; 20-percent beneficial owners; promoters; investment managers and principals of pooled investment funds; persons compensated for soliciting investors; and the general partners, directors, officers, and managing members of any compensated solicitor.

Disqualifying events include: criminal convictions in connection with the purchase or sale of a security; court injunctions and restraining orders; CFTC and other financial regulators’ final orders; certain SEC disciplinary orders; SEC cease-and-deist and stop orders; suspension or expulsion from membership in a self-regulatory organization; and U.S. Postal Service false representation orders.

The disqualification would apply only for events that occur after the effective date of the rule. Events that occurred before the effective date of the rule must be disclosed to investors.

Aguilar’s dissent. Aguilar said that the rule adoption was the right thing to do but that it was far from perfect, given that it only applies to events that occur after the effective date of the rule. The rule also limits the reach of the disqualification, he said, referring to the 20-percent beneficial owner provision instead of the 10-percent threshold as proposed. Rule 506 is the most widely used exemption from registration, he said, yet investors have substantially fewer protections.

The rule amendments will become effective 60 days after publication in the Federal Register.

Investor-protection rule proposal. The rule proposal relating to private placements is intended to enhance the SEC’s ability to assess developments in the market once the ban on general solicitation is lifted. Under the proposal, issuers would be required to file advance notices of sales 15 days prior to an offering and within 30 days after the conclusion of the offering. Issuers would be required to disclose their websites, the securities that are being offered, the types of investors in the offering, the use of proceeds, the types of general solicitation used, and the methods used to verify the accredited-investor status of their investors.

An issuer that fails to file a Form D would be disqualified from the Rule 506 exemption for any new offering for one year. The proposal also requires certain legends or cautionary statements with respect to any written general solicitation materials that are used in the offering. Any written general solicitation materials that are used must be submitted to the SEC. The materials will be nonpublic, and the requirement will expire after two years.

The guidance on fraudulent or misleading sales material for investment companies under Securities Act Rule 156 would be extended to the sales literature of private funds. It would apply regardless of whether the private funds are engaged in general solicitation activities. In the release, the SEC advises private funds to consider the Rule 156 principles now, rather than wait for the rule to be adopted. The comment period on the proposal is open for 60 days.

MainStory: TopStory DoddFrankAct JOBSAct PrivatePlacements

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