Regulation D Rule 506(c) Introduction
Enacted in 2012, the Jumpstart Our Business Startups
Act, or JOBS Act, is intended, among other things, to reduce barriers
to capital formation, particularly for smaller companies. The JOBS Act
requires the SEC to adopt rules amending existing exemptions from
registration under the Securities Act of 1933 and creating new
exemptions that permit issuers of securities to raise capital without
SEC registration. On July 10, 2013, the SEC adopted amendments to Rule
506 of Regulation D and Rule 144A under the Securities Act to implement
the requirements of Section 201(a) of the JOBS Act. The amendments are
effective on September 23, 2013.
Rule 506(c) of Regulation D
Section 201(a) of the JOBS Act requires the SEC to eliminate the
prohibition on using general solicitation under Rule 506 where all
purchasers of the securities are accredited investors and the issuer
takes reasonable steps to verify that the purchasers are accredited
investors.
To implement Section 201(a), the SEC adopted paragraph (c) of Rule 506.
Under Rule 506(c), issuers can offer securities through means of
general solicitation, provided that:
- all purchasers in the offering are accredited investors,
- the issuer takes reasonable steps to verify their accredited investor status, and
- certain other conditions in Regulation D are satisfied.
An “accredited investor” includes a natural person who:
- earned income that exceeded $200,000 (or $300,000
together with a spouse) in each of the prior two years, and reasonably
expects the same for the current year, or
- has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
An “accredited investor” may also be an entity such as a
bank, partnership, corporation, nonprofit or trust, when the entity
satisfies certain criteria.
The JOBS Act requires that issuers wishing to engage in general
solicitation take “reasonable steps” to verify the accredited investor
status of purchasers. Rule 506(c) sets forth a principles-based method
of verification which requires an objective determination by the issuer
(or those acting on its behalf) as to whether the steps taken are
“reasonable” in the context of the particular facts and circumstances
of each purchaser and transaction. Among the factors that an issuer
should consider under this principles-based method are:
- the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
- the amount and type of information that the issuer has about the purchaser; and
- the nature of the offering, such as the manner in
which the purchaser was solicited to participate in the offering, and
the terms of the offering, such as a minimum investment amount.
In addition to this flexible, principles-based method,
Rule 506(c) includes a non-exclusive list of verification methods that
issuers may use, but are not required to use, when seeking greater
certainty that they satisfy the verification requirement with respect
to natural person purchasers. This non-exclusive list of verification
methods consists of:
- verification based on income, by reviewing copies of
any Internal Revenue Service form that reports income, such as Form
W-2, Form 1099, Schedule K-1 of Form 1065, and a filed Form 1040;
- verification on net worth, by reviewing specific
types of documentation dated within the prior three months, such as
bank statements, brokerage statements, certificates of deposit, tax
assessments and a credit report from at least one of the nationwide
consumer reporting agencies, and obtaining a written representation
from the investor;
- a written confirmation from a registered
broker-dealer, an SEC-registered investment adviser, a licensed
attorney or a certified public accountant stating that such person or
entity has taken reasonable steps to verify that the purchaser is an
accredited investor within the last three months and has determined
that such purchaser is an accredited investor; and
- a method for verifying the accredited investor status
of persons who had invested in the issuer’s Rule 506(b) offering as an
accredited investor before September 23, 2013 and remain investors of
the issuer.
Rule 506(b) remains unchanged following the adoption of
Rule 506(c) and continues to be available for issuers that wish to
conduct a Rule 506 offering without the use of general solicitation or
that do not wish to limit sales of securities in the offering to
accredited investors.
Amendment to Securities Act Rule 144A
Rule 144A is a non-exclusive safe harbor exemption from the
registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers, or QIBS. A QIB includes
certain entities that, in the aggregate, own and invest on a
discretionary basis at least $100 million in securities of unaffiliated
issuers. A registered broker-dealer qualifies as a QIB if it owns and
invests on a discretionary basis at least $10 million in securities of
unaffiliated issuers. Prior to the recent amendment to Rule 144A
described below, offers of securities under Rule 144A were required to
be limited to QIBs, which effectively prohibited the use of general
solicitation under Rule 144A.
Section 201(a) of the JOBS Act requires the Commission to revise Rule
144A to provide that securities sold pursuant to Rule 144A may be
offered to persons other than QIBs, including by means of general
solicitation, provided that securities are sold only to persons that
the seller and any person acting on behalf of the seller reasonably
believe are QIBs. To implement Section 201(a), the SEC adopted an
amendment to Rule 144A to permit the use of general solicitation under
Rule 144A, as long as the purchasers are limited to QIBs or to
purchasers that the seller and any person acting on behalf of the
seller reasonably believe are QIBs.
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