July 16, 2013
My Attorney's Comments on the New SEC Advertising Rules
A flood of information is being circulated about lifting the advertising ban when raising money. A lot of what’s coming out is wrong – being perpetrated by marketers.
The securities attorney for my hedge fund has written a digest for his clients and he has given permission to republish his memo here for the benefit of my clients and readers who want to raise money to do deals. What follows is from my attorney, Russ Frandsen, whose contact info is:
Business Legal Group
225 South Lake Avenue, Suite 300
Pasadena, CA 91101
Tel = (626) 432-7229
AT LAST, SEC ISSUES JOBS ACT RULES ALLOWING PUBLIC ADVERTISING FOR REGULATION D 506 OFFERINGS
On July 10, 2013, the SEC issued its final amendments to Rule 506 of Regulation D under the JOBS Act, allowing companies to openly advertise the sale of their securities in offerings to accredited investors.
Under amended Rule 506(c), an issuer may offer securities by general solicitation if the issuer satisfies the following conditions of Rule 506 (and the other applicable provisions of Regulation D):
• all purchasers of securities must be accredited investors, either because they in fact qualify as accredited investors or because the issuer reasonably believes that they are accredited investors at the time of the sale of the securities; and
• the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors.
The “reasonable steps” requirement is a new addition, although one may argue that “reasonable steps” from the issuer were always required. The practice has been that allowing investors to self-certify as an accredited investor reasonably satisfied the issuer’s obligations under Regulation D in determining whether a person met the accredited investor requirements absent countervailing facts.
Under Rule 506(c), “reasonable steps” may require some potential investors to “provide more information to issuers than they currently provide” and issuers “may have to apply a stricter and more costly process to verify accredited investor status than what they currently use.” The term “reasonable“ is an objective determination by the issuer based on the particular facts and circumstances of each purchaser and transaction. The SEC commented that the exemption is not satisfied if the issuer has not taken “reasonable steps” to verify accredited investor status, even if all investors are in fact accredited investors. The SEC included a nonexclusive list of steps that may be used to verify whether a natural person is an accredited investor.
• To determine whether the person had $200,000 of income for the past two years (or $300,000 together with a spouse), reviewing any federal income tax form that reports income, such as Form W-2, Form 1099, Schedule K-1 to Form 1065, and Form 1040, and obtaining a written representation from the person that he or she has a reasonable expectation of reaching the same income level during the current year;
• To determine net worth of over $1,000,000:
• reviewing (1) such documents as bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties; and (2) a written representation by the investor dated within the prior three months stating that all liabilities necessary to make a determination of net worth have been disclosed.
• Obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor.
• Any natural person who invested in an issuer’s Rule 506(b) offering as an accredited investor prior to the effective date of Rule 506(c) and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement in Rule 506(c) with respect to any such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor.
The biggest risk to issuers using general solicitation will be the failure to take “reasonable steps” to verify accredited status. The SEC provided this commentary:
After consideration of the facts and circumstances of the purchaser and of the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify accredited investor status, and vice versa. For example, if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser’s cash investment is not being financed by a third party.
In some circumstances self-certification might still be reasonable, particularly if the self- certification is under penalty of perjury, and if other circumstances suggest that the investor is accredited. However, lawyers advising issuers are likely to be conservative and recommend that issuers rely on one or more of the non-exclusive methods set forth in new subsection 506(c).
The issuer has the burden of proving the availability of the exemption. Accordingly, as with past practice, issuers should maintain detailed records of compliance.
Rule 506(c) does not impose any formal record keeping requirements but issuers should document the steps taken to verify that purchasers are accredited investors. Such record keeping is necessary because the issuer has the burden of demonstrating that its offering is exempt from the registration requirements of Section 5 of the Securities Act.
If the verification of purchasers presents difficulties and issuers do not wish to engage in general solicitation, such issuers still continue to have the ability under Rule 506(b) to conduct Rule 506 offerings subject to the prohibition against general solicitation. The SEC noted that Rule 506(b) represents an important source of capital for issuers of all sizes, and maintains Rule 506(b) availability “for issuers that either do not wish to engage in general solicitation in their Rule 506 offerings (and become subject to the requirement to take reasonable steps to verify the accredited investor status of purchasers) or wish to sell privately to non-accredited investors who meet Rule 506(b)’s sophistication requirements.”
The new Rule 506(c) will become effective 60 days after publication in the Federal Register. Accordingly, the Rule 506(c) should be operative in mid-September 2013.
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We will discuss this material at length at our upcoming Deal Making Symposium. We only take a small group of professionals so do not delay. If you want to join us in Las Vegas, October 6 to 9, 2013, now is the time to make your plans.
Looking forward to seeing you at the Symposium in October.
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Joel is CEO of Bullseye Capital , a full-service real estate company supporting owners and buyers of real estate assets with brokerage, leasing, property management, and mortgage services. Joel is also the founder of the Bullseye Capital Real Property Opportunity Fund, LLC which is an investment company that acquires distressed real estate by working with accredited investors.
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