Securities Lawyer 101 l Brenda Hamilton

Securities Lawyer 101 l Brenda Hamilton

Wednesday, August 28, 2013

Rule 506 l General Solicitation Countdown

Rule 506(c) will become effective in less than a month, on September 23, 2013.   The rule fundamentally changes how private placements will be conducted, by allowing issuers to engage in general solicitation and advertising if specific requirements are met. The SEC has confirmed that the Rule 506(c) exemption will not be forgiving for issuers who engage in general solicitation but fail to comply with its requirements.
Even one sale to a non-accredited investor will prevent the issuer from relying upon the exemption, making it a time bomb for issuers who fail to adopt proper compliance methods for their offerings.  The most significant compliance concern is that issuers make sales only to accredited investors. The advantages offered by  Rule 506(c) are significant for issuers who comply with its inflexible but adaptable requirements.
Pending SEC ProposalsIn the adopting release implementing Rule 506(c), the SEC made proposals and provided some guidance about the steps issuers should take to confirm accredited investor status. These proposals include imposing disclosure and filing requirements for offerings made under Rule 506(c), and changing Form D.   Rule 506(c) will go into effect on September 23, with or without final action on the SEC’s proposals.
Rule 506(c) GenerallyBoth public and private companies can rely upon Rule 506. The exemption is commonly used in going public transactions to raise initial capital and obtain a shareholder base. Rule 506 allows issuers to raise an unlimited amount of capital and there are no limitations on the number of non-accredited investors who can invest. Rule 506(c) allows issuers to advertise their offerings so long as sales are made to accredited investors only.
Issuers should ensure that prior securities offerings made to non-accredited investors are not integrated with a Rule 506(c) offering or the exemption will could be lost.
Simultaneous Offerings Under Rule 506Issuers can either conduct their offering under Rule 506(c) or sell to accredited investors. They cannot conduct simultaneous offerings to both accredited and non-accredited investors if general solicitation and advertising is used.  Issuers must also consider whether any prior Regulation D offerings made to non-accredited investors will be integrated with its Rule 506(c) offering making 506(c) unavailable. Rule 502 (a) of Regulation D provides a safe harbor from integration of Regulation D offerings, made six months before or six months after another offering.  If six months has not elapsed between offerings, the issuer should rely upon the 5 factors set forth in 502(a) to determine whether its prior Regulation D offering will be integrated.
Rule 502(a)’s integration factors include:
● Whether the offerings are part of a single plan of financing;
● Whether the offerings involve the same class of securities;
● Whether the offerings were made at or about the same time;
● Whether the same type of consideration was received in the offerings; and
● Whether the offerings were conducted for the same general purpose.
Once an issuer determines that no prior securities offerings are integrated with its Rule 506(c) offering it can proceed with its Rule 506(c) compliance strategy.  The first step should be to determine how it will confirm accredited investor status.
506(c) Accredited Investor RequirementsIssuers may only use general solicitation and advertising in their Rule 506(c) offerings if sales are made to accredited investors. Under the Securities Act an accredited investor must have either (i) a net worth of at least $1 million, not including the value of his or  her primary residence, or (ii) income of at least $200,000 in each year of the last two years or $300,000 together with his or her spouse if married and have the expectation to earn the same amount in the current year.
Confirming Accredited Investor Status
Rule 506(c) requires that issuers take reasonable steps to verify that Rule 506(c) investors are accredited. The SEC  has indicated that accredited investor status will be an objective determination by the issuer based upon the particular facts and circumstances. The SEC suggested the  methods below.
Income Requirement
The issuer should review tax forms, including W-2s, 1099s, K-1s, and 1040s, that report the purchaser’s income for the two most recent years. The issuer should also obtain written representations from the investor that he or she has a reasonable expectation of reaching the income level necessary to qualify as an accredited investor during the current year.
Net Worth Requirement
Assets
The issuer should review bank, brokerage and other statements of securities holdings, certificates of deposit, tax assessments and appraisal reports that are no more than 3 months old.
LiabilitiesThe issuer should obtain reports from credit agencies. The reports would need to be dated within the prior three months.  The issuer should obtain written representations from the investor that all liabilities necessary to make a determination of net worth have been disclosed.
Third Party Confirmations
The issuer should request written confirmations from third parties such as broker-dealers, investment advisers, attorneys and certified public accountants, that such third party has taken reasonable steps within the prior three months to verify that the purchaser is an accredited investor.
Existing Investors
The issuer should ensure that accredited Investors who purchased prior to September 23 should certify that he or she remains an accredited investor.
The advantages offered by Rule 506(c) are significant for issuers who comply with its inflexible but adaptable rules for issuers who properly prepare for their offering by developing compliance strategies to ensure accredited investor status.
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