By: Paul Bork and Dean F. Hanley (JD Supra)
The JOBS Act (the “Act”), signed into law on April 5, 2012, promises to
have a significant impact on two popular exemptions to registration of
securities under federal securities laws. Currently, any issuer
intending to rely on either Rule 506 of Regulation D or Rule 144A cannot
engage in any general solicitation or advertising to attract investors.
The Act directs the SEC to remove this prohibition. In addition, the
Act exempts certain persons who connect Rule 506 issuers to potential
purchasers from registering as a broker or dealer. Much of the
interpretation of these provisions is left up to the SEC, which has 90
days to publish final rules, and until the SEC publishes its rules, the
current Rules 506 and 144A and related guidance should be followed.
Regardless of whether the shift is subtle or dramatic, the changes to
Rules 506 and 144A will certainly affect how private capital is raised
in the future.
Background
Under federal securities laws, prior to the sale of any securities, the
securities must either be registered with the SEC, or exempt from
registration. One popular exemption for issuers is Rule 506 of
Regulation D, which, subject to a number of conditions, allows an issuer
to sell its securities to so-called “accredited investors” (AIs) in a
private placement transaction. An AI is currently defined as a business
entity with at least $5 million in assets and individuals with a net
worth of at least $1 million (excluding the individual’s primary
residence) or an annual income of at least $200,000 (or $300,000
together with the individual’s spouse). However, in order to qualify for
a Rule 506 exemption, the securities cannot be sold through means of
general solicitation or advertising to the public at large.
A second useful exemption is Rule 144A, which provides an exemption
from registration for the resale, generally by underwriters or
investment houses, of certain types of previously issued securities,
provided that the securities are only offered or sold to “qualified
institutional buyers,” or QIBs. A QIB includes entities that hold at
least $100 million in securities, and other categories of financially
sophisticated entities enumerated in the Rule.
General Solicitation
The Act directs the SEC to amend Rule 506 and Rule 144A to provide as follows:
However, the Act does not identify what “reasonable steps” a Rule 506
issuer must take, or what it means to “reasonably believe” that a
purchaser is a QIB, instead leaving it up to the SEC to provide final
rules within 90 days. Until such time, we do not recommend that an
issuer or Rule 144A seller engage in general solicitation in connection
with a Rule 506 or 144A transaction.
Effect on the Integration Doctrine. Another open question is whether a
Rule 506 offering that is “marketed” by means of a general solicitation
(as will be permissible under revised Rule 506 pursuant to the Act) will
be deemed by the SEC to be part of a subsequent public offering,
thereby rendering the unregistered Rule 506 private placement improper,
and requiring registration of the entire offering. The SEC employs this
doctrine, known as integration, in order to prevent issuers from
improperly circumventing the registration process, but the SEC has made
it clear that under some circumstances an issuer may indeed sell
securities privately while in the process of registering a public
offering. In 2007, the SEC released guidelines addressing the risk of
integration of such concurrent offerings, and emphasized that the
analysis centers on the methods used to solicit investors. Generally,
the SEC will not integrate the two offerings if the issuer does not
solicit investors for the private placement through “general
solicitation.” Given that general solicitation is now allowed in
connection with Rule 506 offerings, this analysis no longer seems clear,
and issuers will require further guidance from the SEC regarding
integration.
Brokers-Dealers
The Act also creates a new exemption from broker-dealer registration
for certain persons facilitating Rule 506 offerings. Specifically, a
person does not have to register as a broker-dealer solely because: (1)
the person maintains a platform or mechanism that permits the offer,
sale, purchase or negotiation of securities in connection with a Rule
506 offering; (2) the person or its affiliates co-invest in the Rule 506
offering; or (3) the person provides ancillary services with respect to
the Rule 506 offering. Ancillary services include due diligence
services, so long as such services do not include investment advice for
separate compensation, and furnishing standard investment documents,
provided that the person does not negotiate the offering terms and the
standard documents are not required to be used by issuers.
Significantly, the person may not receive any compensation in connection
with the sale of securities under Rule 506.
In recent years, various websites emerged to connect willing investors
to companies seeking capital. Under the new exemption, these sites are
now explicitly exempt from having to register as broker-dealers in
connection with Rule 506 transactions originating on their site. The
impact will likely be felt most strongly online, but the language of
this exemption is broad enough to encompass other platforms for
connecting sellers and purchasers as well. Although a person seeking
exemption from broker-dealer registration under this provision cannot
receive compensation in connection with the sale of securities, a
website may be able to charge an access or membership fee that is not
tied directly to the sale of securities. Until the SEC provides more
guidance, it is unclear how or whether such a fee would render a person
ineligible for the exemption.
If you have any questions, please contact Dean Hanley or Paul Bork of
Foley Hoag’s Corporate Finance and Securities Practice Group or (617)
832-1000 or contact your lawyer at Foley Hoag.
Photo Credit: Stuart Miles
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