Peter M. Fass ()
The Securities and Exchange Commission (SEC) on July 10, 2013, adopted amendments to Rule 506 of Regulation D and to Rule 144A under the Securities Act of 1933 (1933 Act) that eliminate the ban on general solicitation and general advertising (hereinafter General Solicitation) of securities offerings conducted under those rules (Final Rules). The amendments significantly liberalize the restrictions on publicity in connection with offers of real estate securities made in reliance on the Final Rules and will permit sponsors of real estate offerings to more broadly solicit investors and publicize their offerings.1
The Final Rule changes were mandated by the Jumpstart Our Business Startups Act (JOBS Act) and became effective on Sept. 23, 2013. The Final Rules were adopted in substantially the form proposed by the SEC in August 2012 with one important addition, the inclusion by the SEC of four non-exclusive methods that issuers may use to verify the accredited investor status of natural persons.2
In addition, the SEC (i) adopted rules mandated under the Dodd-Frank Wall Street Reform and Consumer Protection Act prohibiting certain felons and other bad actors from utilizing Rule 506, and (ii) proposed new amendments to Regulation D and Form D intended to enable the SEC to evaluate the development of market practices in Rule 506 offerings and help address concerns of an increase in fraudulent market activity.3
The Final Rules add a new paragraph (c) to Rule 506, which permits the use of General Solicitation in connection with the offer and sale of securities pursuant to Rule 506, provided that (i) all purchasers of securities are accredited investors, (ii) the issuer takes “reasonable steps” to verify that purchasers are accredited investors, and (iii) the offering complies with the other applicable requirements of Regulation D. Under Rule 501, the definition of “accredited investor” includes persons whom the issuer reasonably believes come within any of the enumerated categories of accredited investor at the time of the sale of the securities to that person.
The Final Rules leave unchanged existing paragraph (b) of Rule 506 that permits an issuer to offer and sell securities, without any limitation on the offering amount, to an unlimited number of “accredited investors,” as defined in Rule 501(a) of Regulation D, and to no more than 35 non-accredited investors, subject to a number of conditions, among which is the requirement that neither the issuer, nor any person acting on its behalf, offer or sell the securities in question through any form of General Solicitation. Rule 506(b) does not require the issuer to undertake the verification process mandated under Rule 506(c).
Reasonable Steps to Verify Accreditation. The JOBS Act left for the SEC the responsibility to determine what are “reasonable steps to verify” accredited investor status. Many comments on the proposed rules urged the SEC to provide for acceptable ways for issuers to meet the new verification requirement. Except with respect to certain limited guidance discussed below, the SEC declined, concluding that requiring specific acceptable methods of verification would be impractical, given the wide range of issuers and the many ways in which a purchaser can qualify as an accredited investor.
Under the Final Rules, whether the steps taken to verify are “reasonable” is an objective determination by the issuer, in the context of the particular facts and circumstances of each purchaser and transaction. The more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it may have to take. “If an issuer has actual knowledge that the purchaser is an accredited investor, then the issuer will not have to take any steps at all.”4 The SEC stated that it would expect issuers to look at factors such as (i) the nature of the purchaser; (ii) the amount and type of information that the issuer has about the purchaser; and (iii) the nature and terms of the offering.
Nature of Purchaser. In some cases, the determination could be very simple where, e.g., the purchaser may be an accredited investor because it is a registered broker-dealer or investment adviser, in which case a reasonable check for verification would be confirming the registration rolls of FINRA (in the case of broker-dealers) or the SEC (in the case of an investment adviser).
Information About Purchaser. Examples of the types of information that an issuer may review include publicly available filings with a federal, state or local regulatory agency, such as proxy statements, as well as third-party information that provides reliable information that a person falls under a category of accredited investor. Third-party information may include W-2s, trade publications that disclose annual compensation, or verification by a third party, such as a broker-dealer, attorney or accountant, provided that the issuer has a reasonable basis to rely on such third-party verification.
Nature and Terms of the Offering. If the offering is conducted through a website, e-mail or social media, it will require more verification than if new investors are solicited through a pre-screened database monitored by a reliable third party. In contrast, the SEC stated that if the terms of the offering require a high minimum investment amount, such that only an accredited investor could reasonably meet it, it may be reasonable for an issuer to rely on a direct cash investment (provided that it is not financed by the issuer or a third party). The Adopting Release at 33-34 made clear the SEC’s belief that receipt of a response to a questionnaire indicating that a prospective purchaser is an accredited investor would not, alone, satisfy the verification requirement.
In the Adopting Release, the SEC acknowledged that determining accredited investor status poses greater difficulties as to natural persons than other persons. In response to comments, the SEC included in the Final Rules a non-exclusive list of verification methods (Rule 506(c)(ii)(A)) that (all but the third) are available only for prospective investors who are natural persons:
(1) In verifying whether a natural person is an accredited investor on the basis of income, an issuer is deemed to satisfy the verification requirement by reviewing copies of the investor’s federal tax forms for the two most recent years, 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.
(2) In verifying whether a natural person is an accredited investor on the basis of net worth, an issuer is deemed to satisfy the verification requirement by reviewing one or more of the following types of documentation, dated within the prior three months and by obtaining a written representation from such person that all liabilities necessary to make a determination of net worth have been disclosed.
• 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 are deemed to be satisfactory.
• For liabilities: A consumer report (also known as a credit report) from at least one of the nationwide consumer reporting agencies is required.
(3) In determining whether a person or an entity is an accredited investor, an issuer satisfies the requirement by receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that they have taken reasonable steps to verify the purchaser’s accredited status within the prior three months.
Note that none of these methods will be deemed to satisfy the verification requirement if the issuer or its agent has knowledge that the purchaser is not an accredited investor.5
1. See www.sec.gov/rules/final/2013/33-9415.pdf (“Adopting Release”).
2. The proposing release is available at www.sec.gov/rules/proposed/2012/33-9354.pdf.
4. Adopting Release at n.111.
5. Adopting Release at n.116.