SEC Proposal: Relaxing Solicitation and Advertisement Prohibitions for Private Placements under the JOBS Act

Written by Craig F. Zappetti*

The Securities and Exchange Commission (SEC) proposed new regulations to implement provisions of the Jumpstart Our Business Startups Act  (JOBS Act), eliminating prohibitions on general solicitation and advertising in certain private placement offerings to accredited investors.  The public comment period for these proposed regulations has expired and the SEC should issue final regulations later this Fall.

Under § 201(a) of the JOBS Act, the SEC is obligated to implement rules allowing for general solicitation in certain circumstances, amending current Rule 506 of the Securities Act of 1933.  Currently, Rule 506 allows issuers to sell securities in a private placement offering of an unlimited offering amount to an unlimited number of accredited investors and up to 35 non-accredited investors who meet certain sophistication requirements. The safe harbor of Rule 506 is currently conditioned on the issuer not offering or selling the securities through any form of “general solicitation” or “general advertising.”  The safe harbor restrictions effectively limit offers of securities in private placement offerings to either persons within an issuer’s business network with whom they have a pre-existing relationship or persons referred by a registered broker-dealer who was paid a commission for the referral by the issuer, thus limiting the success and/or increasing the cost of these offerings. The JOBS Act requires removal of these restrictions in offerings made solely to accredited investors so that issuers can more easily identify accredited investors and raise the money they need to grow their businesses.  State and federal securities regulators have raised concerns that the use of advertising and other forms of general solicitation in private placement offerings will make it easier for dishonest issuers to execute Ponzi schemes and other fraudulent transactions.

Proposed rule Rule 506(c) permits the use of general solicitation to offer and sell securities under Rule 506 to accredited investors so long as (i) the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors, (ii) all purchasers are accredited investors either because they meet the definition in Rule 501(a) or the issuer reasonably believes that they do at the time of sale of the securities, and (iii) all terms and conditions of Regulation D other than the general solicitation restriction are satisfied.  A new Rule 506(b) preserves the existing ability of issuers to conduct Rule 506 offerings without the use of general solicitation.

Whether the steps taken by the issuer are reasonable will be an objective determination, based on the facts and circumstances of each transaction. Under this approach, issuers should consider a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor including:  1) nature of the purchaser and the type of accredited investor he claims to be; 2) amount and type of information that the issuer has about the purchaser; and 3) nature of the offering, such as the manner in which the purchaser was solicited, and the terms of the offering.

An issuer should retain adequate records that document the particular steps taken to verify that a purchaser was an accredited investor at the time of investment.   While many of the practices currently used by issuers in connection with existing Rule 506 offerings would satisfy the proposed verification requirement, the particular facts and circumstances of each offering and each accredited investor will dictate whether additional steps will be necessary to satisfy the reasonableness standard. The issuer must take reasonable steps to verify that the purchaser was an accredited investor and must have had a reasonable belief that such investor was an accredited investor at the time of the securities sale.

* Craig F. Zappetti is a partner at Saul Ewing LLP, and the chair of its Securities Transactions and Regulations Practice.  As chair, Craig Zappetti concentrates his practice on providing securities compliance counsel to private and public companies, representing venture capital funds and early stage companies in financing transactions, counseling both buyers and sellers in mergers and acquisitions, counseling investment advisers on regulatory compliance matters and providing general counsel to private and public companies regarding corporate matters.

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