Many of our clients have asked how to take advantage of the Jumpstart Our Business Startups Act (JOBS Act), a groundbreaking piece of legislation that eases the restrictions of the federal securities laws governing the private placement of securities.
The JOBS Act received wide bipartisan support despite protests from state and federal securities regulators. One of the most fundamental changes was a narrow exception to the long-standing ban on solicitation of and advertising to the general public regarding private placements of securities — the issuance of stock that is not registered with the Securities and Exchange Commission and therefore not publicly traded.
The SEC was vocal in its concerns about the legislation and has been predictably slow to enact regulations to implement it. Finally on July 10, 2013, the SEC adopted the requisite regulatory amendments, which will be effective on September 23, 2013. The SEC also proposed rules that would create additional notice obligations and disclosure requirements for publicly promoted offerings. Although the new and proposed rules permit public advertising, they also impose new responsibilities on those issuers who wish to do so, which make this approach more difficult, expensive, and risky than offerings without public advertising.
The JOBS Act directs the SEC to remove the prohibition on general solicitation or general advertising for securities offerings relying on the most commonly used safe-harbor exemption from federal registration — Rule 506 of Regulation D — so long as the issuer of the securities takes "reasonable steps" to verify that all purchasers are accredited investors. In other words, there is no restriction on whom an issuer can tell about this type of securities offering, but the issuer must try to limit the purchasers of the securities to accredited investors only, and comply with the other requirements of Rule 506.
The term "accredited investor" is defined in Regulation D to include (i) a variety of specifically defined entities which by their regulated status or their high net worth are deemed to be able to fend for themselves, and (ii) any individual with either:
The new Rule 506(c) does not list or define the "reasonable steps" that must be taken to determine accredited investor status, but the SEC has published a non-exclusive list of examples, including:
These examples strongly suggest that traditional methods of verification — such as having investors complete offeree questionnaires or a check-box certification of their accredited status without providing supporting documentation — are inadequate. The time and effort it will take issuers to take these additional steps, and the likelihood of investor resistance to this level of disclosure, should not be underestimated.
Making matters more challenging is the SEC's statement that the appropriateness of a particular method of verification will depend on the following factors:
Until there is some track record from which to gauge the SEC's application of these vague guidelines to specific scenarios, there will be unavoidable risk in public solicitation.
As noted above, issuers relying on Rule 506 have always been required to file a notice (Form D) of the transaction with the SEC. Form D has been amended as part of the new rules to require issuers to indicate whether or not the offering involves general solicitation. In offerings not involving public solicitation, the Form D will continue to be due 15 days after the offering. But for offerings using public solicitation, the SEC has proposed new rules that would provide:
The proposed rules would also provide that issuers who fail to timely make any of the necessary Form D filings in a Rule 506 offering could be disqualified from relying on Rule 506 for a full year from the date of the corrective filing. If these rules are enacted, they will obviously add another significant planning and disclosure element to offerings involving public solicitation.
Each company raising capital must of course decide for itself if the opportunity to advertise publicly justifies the more rigorous responsibility for verifying each purchaser's accredited investor status. For some companies, unable or unwilling to raise capital through traditional angel and venture channels, or having a particularly strong appeal to the broader investing public, the new flexibility may provide a better conduit to previously unavailable funding sources. For others, the traditional private placement to known funding sources will continue to be less expensive and cumbersome — the SEC has made it clear that "issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren't subject to the new verification rule."
To the entrepreneur in desperate need of funding, splashing the details of a stock offering across the Internet or promoting it in industry publications may look compellingly attractive, but the decision to promote publicly has many implications that should be weighed carefully. Aside from the additional purchaser-verification burden under the new SEC rules, issuers should also consider:
This Legal Update does not constitute legal advice and does not create an attorney-client relationship. For more information about the new rules, or to discuss how your company can raise funds through a private offering, contact Greg Beattie
