By Craig A. Foster
The recently enacted Jumpstart Our Business Startups Act (JOBS Act) directs the U.S. Securities and Exchange Commission (SEC) to adopt rules that remove the existing prohibition against general advertising and general solicitation in private placements exempt from registration under Rule 506 of Regulation D, as long as the securities are sold only to accredited investors. The JOBS Act directs the SEC to adopt those rules by July 4, 2012. Until the SEC does so, issuers relying on Rule 506 should continue to implement customary selling practices designed to avoid general solicitation and general advertising.
Background. Rule 506 sets a list of conditions, upon satisfaction of which, an offering of securities will be exempt from the registration requirement under the Securities Act of 1933, as amended. Under Rule 506, an issuer may sell securities to an unlimited number of accredited investors and up to 35 nonaccredited investors, as long as (a) each nonaccredited investor, alone or with a purchaser representative, is financially sophisticated; and (b) certain additional financial disclosures are provided to each nonaccredited investor.
Current Prohibition on General Solicitation and Advertising. Currently, Rule 506 prohibits an issuer of securities, or any person acting on its behalf, from offering or selling the securities by any form of “general solicitation or general advertising.” SEC guidance has indicated that to comply with that prohibition in practice, an issuer should have a “substantial pre-existing business relationship” with a prospective investor that allows the issuer to be aware of the prospect’s financial circumstances.
Modification of Rule 506. The JOBS Act requires the SEC to modify Rule 506 to eliminate the prohibition against general solicitation and advertising provided that the securities are sold only to accredited investors. The JOBS Act directs the SEC to modify Rule 506 by July 4, 2012, and states that the modified rule must require issuers to take reasonable steps to verify that all investors are accredited (using methods to be determined by the SEC).
Action Items. Until the SEC amends Rule 506, issuers relying on that rule should continue to (a) implement customary selling practices designed to avoid general solicitation and general advertising and (b) ensure the existence of a substantial pre-existing business relationship with all prospective investors.
By Craig A. Foster