Offerings to Accredited Investors: Getting Ready for "General Solicitation"

The following is from material for a presentation I will give on the changes to angel investing at a seminar, TAKING ADVANTAGE OF THE JOBS ACT, New Strategies For Raising Capital For Emerging Companies, to be held in Seattle this week. I greatly benefited from Dan Hansen's analysis of Title II of the JOBS Act. 

Title II of the Jumpstart Our Business Startups (JOBS) Act, Public Law 112-106, requires the Securities and Exchange Commission to revise Rule 506 of Regulation D, to provide that the prohibition against general solicitation or general advertising (one of the general conditions of Regulation D that currently must be met to qualify for the Rule 506 exemption) shall no longer apply to offers and sales of securities otherwise exempt under Rule 506, “provided that all purchasers of the securities are accredited investors.”

The new law states that the SEC is to so revise Rule 506 by early July, 2012.

Moreover, Title II of the new law specifies that, in revising Rule 506, the SEC will promulgate new rules that “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.”

Title II also calls upon the SEC to revise Rule 144A, to provide that securities sold under that exemption may be offered by general solicitation or general advertising, provided that such sales are restricted “to persons that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer.”

Many startups and emerging companies raising private capital today, for whom Rule 506 is often the exemption of choice, already restrict their private offerings to accredited investors. This is generally the case, even though Rule 506 today permits up to 35 non-accredited investors to purchase securities under the exemption.

So the changes to Rule 506 mandated by the JOBS Act would largely appear to be permissive: it should soon be okay to advertise your offering, as long as, at the end of the day, and consistent with prevalent practice today, all of the purchasers are accredited. Gray areas, such as “tweeting for investors,” should no longer be gray, but instead expressly okay – again, as long as, at the end of the day, you make sure all of your purchasers are accredited, just as you do now.

But is the lifting of the prohibition on general solicitation and general advertising under Rule 506 really that straightforward? Are the changes that will come to Rule 506 of a nature that current practices – what issuers typically do now – going to change for every issuer relying on Rule 506 in the future, whether or not the issuer engages in general solicitation or general advertising?

As you key on the language of Title II of the JOBS Act, and as you consider the interplay of Rule 506 with the new crowdfunding exemption (Title III of the JOBS Act), a number of potentially thorny questions come to the fore:

• Will it be as easy, tomorrow, as it is today, to establish that you’ve limited a Rule 506 offering to accredited investors? What “methods” will the SEC determine an issuer should use, to establish that an investor in a Rule 506 offering is accredited? Is it possible that the SEC, perhaps keeping in mind that it is already going to need to write income and net worth verification rules for the crowdfunding exemption, will make the process of verification far more formal and expensive than it is today?
• If you engage in general solicitation and general advertising, and it turns out later that you blew the new Rule 506 exemption because one of the investors was not accredited, did you engage in a public offering? Presumably the prohibition on general solicitation and general advertising still applies to Rule 506 offerings where there is a single non-accredited investor participating. Or will the SEC’s revisions to Rule 506 eliminate the concept of a Rule 506 offering that includes any non-accredited investors?
• Will “the old 506” still be available for issuers who don’t want to experiment with general solicitation, at least not right away? Or will the new “methods” to verify accredited investor status apply to all issuers relying on the Rule 506 exemption, even those that that do not engage in general solicitation or general advertising?

Pending SEC rulemaking, the prohibition on general solicitation remains in effect. See this report:  The JOBS Act and General Solicitation:  Impact on Private Offerings During the Period Prior to SEC Rulemaking.

Photo: "Brigadier general points out the place where he was wounded to a Belgian general," from National Library of Scotland / Flickr.