Hamilton & Associates Securities Attorneys
October 9, 2012
On August 12, 2012, the Securities and Exchange Commission proposed rules to eliminate the prohibition against general solicitation and general advertising in offerings conducted pursuant to Rule 506 of Regulation D of the Securities Act and Rule 144A of the Securities Act.
Issuers seeking capital through the sale of their securities must either register the securities with the SEC or comply with an exemption from registration. Section 201(a)(1) of the JOBS Act directs the SEC to amend Rule 506 to permit general solicitation and general advertising provided that all investors are accredited. In this regard, the JOBS Act requires that the issuer take reasonable steps to verify that purchasers of the securities are accredited, using such methods as determined by the SEC.
The new proposals will apply to all issuers including SEC reporting issuers as well as to non-reporting issuers quoted on the OTC Markets Pink Sheets. These proposals will make it easier for issuers to obtain the shareholders necessary to obtain a ticker symbol and encourage issuers to go public direct without an underwriter and undertake direct public offerings instead of reverse mergers with public shells.
The JOBS Act also requires the SEC to revise Rule 144A, which governs the resale of securities by qualified institutional buyers (QIBs). Under existing Rule 144A, offers of securities can only be made to QIBs. Under the JOBS Act, Rule 144A would be revised so that offers of securities could be made to investors who are not QIBs as long as the securities are sold only to persons whom the seller reasonably believes are QIBs.
The Proposed Rules
Under the SEC’s proposed rules, issuers would be permitted to use general solicitation and advertising to offer securities, if the issuer takes reasonable steps to verify that the investors are accredited investors. All investors are accredited, because either they are within one of the categories of persons who are accredited investors under current Rule 501 or the issuer reasonably believes that the investor falls into one of the categories at the time of its purchase of the securities.
Under Rule 501, an accredited investor is:
i. an individual with a net worth or joint net worth with a spouse that exceeds $1 million, excluding the value of his or her primary residence; or
ii. an individual whose income exceeded $200,000 or joint income with a spouse exceeding $300,000 in the two most recent years who has a reasonable expectation of the same income in the current year.
In determining the reasonableness of the steps taken by an issuer to confirm that an investor is accredited, the proposing provides that issuers should consider:
i. The type of purchaser and the type of accredited investor that the purchaser claims to be.
ii. The amount and type of information that the issuer has about the purchaser.
iii. The manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as the minimum investment amount.
The SEC’s proposing release notes that propose specific verification methods for issuers to use would be impractical and potentially ineffective because of the many ways an investor can qualify as accredited.
The proposed rules preserve Rule 506 as a separate exemption which would allow issuers conducting 506 offerings without the use of general solicitation and advertising to rely upon the rule as it currently exists without being subject to the proposed verification rule.
Under the proposals, securities sold pursuant to Rule 144A can be offered to persons other than QIBs, including by general solicitation and advertising, so long as the securities are sold only to persons whom the seller reasonably believes are QIBs.
The proposed rules would amend Form D, which issuers must file with the SEC when they sell securities under Regulation D including Rule 506. The proposed form would require that issuers check if they are claiming the new Rule 506 exemption that would permit general solicitation and advertising.
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