On July 10, 2013, the Securities and Exchange Commission lifted an 80-year old ban on the general solicitation of private securities offerings to individual investors. The decision came as a response to Section 201(a) of the Jumpstart Our Business Startups (JOBS) Act of 2012, which amends Rule 506 of Regulation D under the Securities Act of 1933. The SEC summarizes the amendment as follows:
The amendment to Rule 506 permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors. The amendment to Rule 506 also includes a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons. 1
What constitutes general solicitation or general advertising?
While the 1933 Act never defined “general solicitation” or “general advertising,” the new amendment to Rule 502(c) provides a non-exhaustive list of “forms” of general solicitation and general advertisement: “[a]ny advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and [a]ny seminar or meeting whose attendees have been invited by any general solicitation or general advertising . . .” 2
What makes a natural person an accredited investor?
“Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.” 3 The person’s net worth may not include, as an asset, the person’s primary residence, but it also excludes, as a liability, any indebtedness secured by the person’s primary residence (up to the fair market value of the primary residence). 4 An accredited investor can also be “[a]ny natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.” 5
What are “reasonable steps” to verify that purchasers are accredited investors?
Regardless of whether or not an investor is actually accredited, issuers must be able to show that they took “reasonable steps” to verify the investor’s status as an accredited investor prior to the sale. Instead of requiring a uniform verification process that may be ill-suited or unnecessary for a particular offering or purchaser, the SEC has decided to take a principled approach that applies an objective standard to the facts and circumstances of each situation. In doing so, it recommends that issuers consider the following factors:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the issuer has about the purchaser; and
- the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount. 6
In addition to the principles-based approach, Rule 506(c) includes a non-exclusive list of verification methods that the SEC deems adequate for verifying accreditation. The four methods listed are:
- Reviewing copies of any Internal Revenue Services form that reports income for the two most recent years, e.g., Form W-2 (wages), Form 1099 (other sources of income), and Form 1040 (individual income tax return), “along with obtaining a written representation from such person that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year.” 7
- “Obtaining a written representation from such person that all liabilities necessary to make a determination of net worth have been disclosed” and reviewing the following types of documentation, dated within the prior three months: “for assets: bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports issued by independent third parties . . . and for liabilities: a consumer report (also known as a credit report) from at least one of the nationwide consumer reporting agencies is required.” 8
- “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.” 9
- Self-certification of “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 . . .” 10
What effect will the new rules have?
September 23, 2013, signaled the aforementioned rules going into effect, as well as the closing of the public comment period for a new proposal. The new proposal deals with the SEC filing requirements for issuers who are generally soliciting their investment opportunities. The new proposal may largely shape the final regulations, so there is still a great deal of uncertainty regarding the actual effect of these new rules.
On one side of the forecasts, there are predictions that the new rules will be too burdensome on investors and startups, while the other side projects the benefits largely outweighing the restrictions. Marianne Hudson, Executive Director of the Angel Capital Association, worries that because angel investors will not be able to self-certify their accredited status for solicited deals, fewer angels will invest as a result of the new rules. 11 Still, many people feel that with the new rules, “financial capital will be able to transcend geographic borders and flow freely to startups throughout the country.” 12 Theories abound, but hopefully with the closing of the public comment period, the SEC will provide some concrete ideas of what lies ahead for the general solicitation of private securities offerings.
Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 78 Fed. Reg. 44,771, 44,771 (July 10, 2013) (to be codified at 17 C.F.R. pts. 230, 239). ↩
17 C.F.R. § 230.502(c) (West, Westlaw through 2013). ↩
17 C.F.R. § 230.501(a)(5) (West, Westlaw through 2013). ↩
17 C.F.R. § 230.501(a)(6) (West, Westlaw through 2013). ↩
Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 78 Fed. Reg. at 44,778. ↩
Id. at 44,781. ↩
Marianne Hudson, New SEC Rules Could Kill Angel Investing, Angel Insights Blog (Jul. 15, 2013), http://www.angelcapitalassociation.org/blog/new-sec-rules-could-kill-angel-investing. ↩
Charles Stack, Welcome to the Dawn of Stock Marketing, The Huffington Post (Sept. 23, 2013, 6:37 PM), http://www.huffingtonpost.com/charles-stack/welcome-to-the-dawn-of-st_b_3977362.html. ↩
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