SEC adopts changes to Reg D

News Brief

By Cydney Posner

At an open meeting this morning, the SEC adopted a number of amendments to Reg D and Rule 144A as required under the JOBS Act and Dodd-Frank, and proposed additional rules to facilitate monitoring of Rule 506 offerings. It was noted at the meeting that amounts raised under Rule 506 are almost comparable to those raised in registered public offerings. Neither the press release nor the rule releases have yet been posted.

In particular, the SEC took the following actions:

  • Adopted, by a vote of four to one, amendments to eliminate the prohibition against general solicitation and general advertising in certain securities offerings conducted pursuant to Rule 506 of Reg D and Rule 144A, as mandated by Section 201(a) of the JOBS Act. Under Reg D, sales must be made only to accredited investors, and the issuer must take reasonable steps to verify the purchasers' accredited status. Although verification can be "principles-based," in response to comments, the rule also includes a non-exclusive list of methods to verify the accredited status of natural persons, based on income and net worth, third-party verification and status as an existing investor. Under Rule 144A, references to "offer" and "offeree" have been eliminated, and general solicitation may be used only for purchasers that are QIBs or reasonably believed to be QIBs.
  • Adopted, by a unanimous vote, amendments to disqualify securities offerings involving certain felons and other "bad actors" from reliance on the Rule 506 exemption, as mandated by Section 926 of Dodd-Frank. The categories of persons that will lead to issuer disqualification were narrowed in response to comments. In addition to the issuer itself, covered individuals include directors, executive officers and other officers participating in the offering, as well as beneficial owners of at least 20% of the outstanding and certain investment managers. However, the disqualification will apply only to events after the effective date of the new rule, although events that occurred before the effective date must be disclosed in writing to investors.
  • Proposed, by a vote of three to two, amendments to Reg D, Form D and Rule 156 (relating to investment company sales literature), intended to enhance the SEC's ability to evaluate changes in the market and to address the development of practices in Rule 506 offerings. This proposal is designed to allow the SEC to monitor, through an action plan, changes in market practices that result from the elimination of the ban. Under the proposal, companies would be required to file a Form D at least 15 days prior to commencing a general solicitation and an amendment within 30 days after completion of the offering. The information required on Form D regarding the issuer and the investors would be expanded and would include the methods used to verify accredited status. Issuers that failed to file the Form D within the preceding five years would be disqualified for one year, although there would be cure periods for late filings. New Rule 509 would require legends on general solicitation materials. Rule 156 would be expanded to cover sales literature for private funds. For a period of two years, issuers would be required to submit to the SEC any written general solicitation materials, although the materials would not be made public. The SEC is also seeking comment on possible updating of the definition of "accredited investor."

You'll recall that the elimination of the ban on general solicitation has been quite controversial. At one point, both Commissioners Walter and Aguilar argued that more safeguards should be considered before the ban was lifted (see my article of 11/16/12). As initially proposed, the rules were widely criticized by consumer and investor advocacy organizations, as well as state securities regulators, on the basis that elimination of the ban would open the floodgates for fraud. In addition, Senator Carl Levin sent a comment letter to the SEC criticizing the lack of certainty under the proposal and asserting that the provision in the JOBS Act prohibiting general solicitation was intended to apply to operating businesses only and not to private investment vehicles at all. (Note that this latter point was not addressed during the open meeting.) (See my article of 10/31/12.)

The new rules and rule proposals were a kind of packaged effort to address the Congressional mandate in the JOBS Act, while attempting to maintain investor protection. Apparently, the package was enough to mollify Commissioner Walter, but Commissioner Aguilar was unwilling to go along. In his view, the rules adopted come at the expense of investor protection. He reiterated that the record supports the argument that elimination of the ban on general solicitation will facilitate fraud and viewed the adoption of the rules without appropriate safeguards as "reckless." He also contended that the proposal to study the practical effects and then adopt rules if necessary would come too late –closing the barn door after the horses have already escaped. Although he voted for adoption of the disqualification rule, he also objected to the narrowing of the categories of individuals covered, as well as the application to only prospective events, especially given the two-year delay in adoption of the final rule. On the other side of the aisle, Commissioners Paredes and Gallagher both objected to the proposal to facilitate monitoring of market changes resulting from elimination of the prohibition. They both viewed the proposal as placing an undue burden on capital formation and undermining the objectives of the JOBS Act.

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