New Rules for Securities Offerings
July 22, 2013
By: Gil B. Selinger
On July 10, 2013, the SEC approved final rules eliminating the prohibition against general advertising and general solicitation (“Advertising”) in certain securities offerings, one year after the deadline imposed by Congress. A person seeking to raise capital (an “Issuer”) can now reach out to the masses when they need capital in any medium imaginable: internet, TV, text messages, Twitter, newspapers, magazines, Facebook, email, LinkedIn, etc. The universe of private securities will no longer be controlled by who you know, but by how you can present and sell your business plan to potential investors who may seek you out, as much as you seek them. However, with easier access to capital comes increased risk on the Issuer to verify the Accredited Investor (as defined in Rule 501 of Regulation D, promulgated under the Securities Act of 1933) status and identification of the potential investor in a way never before required.
The New Opportunity: Final Rule 506(c), General Solicitation and General Advertising
For 80 years, the Securities Act of 1933 prevented an Issuer from any form of Advertising to the public in an offering of private securities. The practical effect was that an Issuer had to meet the right angel, venture capitalist, or private equity fund, or have their own list of potential investors. Without knowing investors, an Issuer was never going to find capital. This status quo changed with the repeal of the ban on Advertising. This is a game changer in the world of private investment; an Issuer will now be able to use Advertising to find potential investors. New Rule 506(c) will be effective 60 days following publication in the Federal Register.
Rule 506(c) creates a new exemption that is available to an Issuer using Advertising if both the following criteria are met:
- The Issuer takes reasonable steps to verify that the investors are “Accredited Investors;” and
- All purchasers are Accredited Investors or the Issuer reasonably believes that the purchaser is an Accredited Investor. An Issuer can advertise to anyone, but may only SELL to Accredited Investors.
The New Risks: Verifying Accredited Investor Status and Investor Relations
While companies may now have easier access to capital, the Issuer must now bear the risk of evaluating the purchaser. Before Rule 506(c), most Issuers placed the onus on the purchaser to verify their Accredited Investor status by having them check a box on a questionnaire. The Issuer then relied on the purchaser’s representations. That will no longer be sufficient.
In an effort to provide guidance to Issuers, the SEC provided a non-exclusive list of methods that may be used to satisfy the verification requirements including:
- The Issuer may review various information on the purchaser, including, but not limited to, tax returns or other financial statements or written confirmation from financial or legal advisors to the purchaser of the purchaser's accredited status;
- The nature of the purchaser and the type of Accredited Investor the purchaser claims to be; and
- The terms and nature of the offering, including how the purchaser was solicited.
As a result, the new dilemmas for an Issuer using Advertising are how to objectively and reasonably verify an Accredited Investor is actually accredited and the fact that the Issuer will have to create their own process to do so. The inquiry will be facts and circumstances sensitive, each requiring an examination of how the Issuer determines if a proposed purchaser is, in fact, accredited.
Rule 506(c), while appealing, leaves some untouched outside risks to the Issuer who is contemplating using this exemption. These risks include:
- A person seeking to raise capital still cannot make a material misstatement or omission of fact in any offering materials, including Advertising. Issuers likely will continue to need to use private placement memorandums, including extensive data on their company and their risks.
- Utilizing Advertising may bring unwanted smalltime investors, unsophisticated investors, or investors who just demand attention. An Issuer must carefully consider the minimum investment amount they are willing to accept and diligently review the identity of the potential purchaser.
- When a venture capitalist or private equity fund invests, it requires documents that protect its interests, such as tag along and drag along rights. In a situation involving Advertising, Issuers will need to create core protective documents for the purchasers, including, at a minimum, a Shareholders Agreement.
The existing provisions of Rule 506 are not affected by Rule 506(c). Rule 506 offerings that are conducted without the use of Advertising can continue to sell securities in the same manner as before, are not subject to the new verification rule, and can continue to use “check the box” questionnaires. If the Issuer can undertake these risks, and wade through information to find qualified investors who are truly accredited, there is enormous potential in Rule 506(c).
This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.
Copyright © 2013 Fairfield and Woods, P.C., ALL RIGHTS RESERVED.
Comments or inquiries may be directed to: Gil B. Selinger