Yesterday, July 10th, under the provisions of the JOBS Act the SEC passed its Final Rules which amended Rule 506 and Rule 144A to lift the ban on general solicitation and advertising in offering and selling securities in a Rule 506 sale as long as all purchasers of the securities are accredited investors.
The burden to ensure that all purchasers are accredited is on the issuer. This comes directly from the JOBS Act Section 201(a)(1): “[s]uch rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” The SEC has given examples of acceptable methods of verification. The first, is by viewing any IRS form that reports income of the investor for the two most recent years, along with 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. The second is that the issuer may also review any of the following documents which are dated within the last three months and obtaining a representation that all liabilities needed for the determination were disclosed: bank statements, securities holdings documentation, CODs, tax assessments and appraisals, and for liabilities – a credit report (note that this might not show all liabilities, but its the only example the SEC gave). A third way an issuer can verify an accredited investor’s status is through a written confirmation from a registered broker-dealer, investment advisor, an attorney, or a CPA stating that the verifier has taken reasonable steps to ensure such confirmation.
I envision that more sites and portals which will offer investment will pop up and start to pre-approve accredited investors so that if a company takes investment through one of such sites it will be able to sufficiently verify the status of all of its investors. Otherwise, it will create a little more work for issuers and their lawyers, who used to be able to rely on a representation in an agreement that the investor was accredited (and sometimes by using a mere question and answer sheet).
Form D is also being amended to have a checkbox as to whether the issuer used any general solicitation or advertising in the offering, in effect whether the offering was under 506(c) or 506(b). The former exemption would allow general solicitation and advertising but only be available if all sales are made to accredited investors, and the latter is the historical 506 offering where sales can be made to an unlimited amount of accredited investors and up to 35 non-accredited investors, but no general solicitation or advertising is allowed. Rule 506(b) and 506(c) are mutually exclusive.
The SEC also passed amendments that disqualify “felons” and other “bad actors” from participating in Rule 506 offerings.
You can count on seeing more ads on TV, in newspapers and in magazines for hedge funds and other sorts of funds. The risk of fraud is always there, but considering that most accredited investors are sophisticated enough to fend for themselves and absorb most losses, this is a good step forward. It took the SEC awhile to get through the comment period but it looks like the Final Rules are going to stimulate more investment. They will, if nothing else, allow more companies and funds to get their message accross to more potential investors.