# Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2013-16883 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** July 24, 2013 - **Citation:** 78 FR 44771 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 230, 239 and 242 [Release No. 33-9415; No. 34-69959; No. IA-3624; File No. S7-07-12] RIN 3235-AL34 Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings AGENCY: Securities and Exchange Commission. ACTION: Final rules. SUMMARY: We are adopting amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act of 1933 to implement Section 201(a) of the Jumpstart Our Business Startups Act. The amendment to Rule 506 permits an issuer to engage in general solicitation or general advertising in offering and selling securities pursuant to Rule 506, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors. The amendment to Rule 506 also includes a non-exclusive list of methods that issuers may use to satisfy the verification requirement for purchasers who are natural persons. The amendment to Rule 144A provides that securities may be offered pursuant to Rule 144A to persons other than qualified institutional buyers, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are qualified institutional buyers. We are also revising Form D to require issuers to indicate whether they are relying on the provision that permits general solicitation or general advertising in a Rule 506 offering. Also today, in a separate release, to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, we are adopting amendments to Rule 506 to disqualify issuers and other market participants from relying on Rule 506 if “felons and other `bad actors' ” are participating in the Rule 506 offering. We are also today, in a separate release, publishing for comment a number of proposed amendments to Regulation D, Form D and Rule 156 under the Securities Act that are intended to enhance the Commission's ability to evaluate the development of market practices in Rule 506 offerings and address certain comments made in connection with implementing Section 201(a)(1) of the Jumpstart Our Business Startups Act. DATES: The final rule and form amendments are effective on September 23, 2013. FOR FURTHER INFORMATION CONTACT: Charles Kwon, Special Counsel, or Ted Yu, Senior Special Counsel, Office of Chief Counsel, Division of Corporation Finance, at (202) 551-3500, or, with respect to private funds, Holly Hunter-Ceci, Senior Counsel, Chief Counsel's Office, or Alpa Patel, Senior Counsel, Investment Adviser Regulation Office, Division of Investment Management, at (202) 551-6825 or (202) 551-6787, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549. SUPPLEMENTARY INFORMATION: We are adopting amendments to Rule 144A, 1 Form D, 2 and Rules 500, 3 501, 4 502 5 and 506 6 of Regulation D 7 under the Securities Act of 1933, 8 and to Rules 101, 9 102 10 and 104 11 of Regulation M 12 under the Securities Exchange Act of 1934. 13 1 17 CFR 230.144A. 2 17 CFR 239.500. 3 17 CFR 230.500. 4 17 CFR 230.501. 5 17 CFR 230.502. 6 17 CFR 230.506. 7 17 CFR 230.500 through 230.508. 8 15 U.S.C. 77a et seq. 9 17 CFR 242.101. 10 17 CFR 242.102. 11 17 CFR 242.104. 12 17 CFR 242.100 through 242.105. 13 15 U.S.C. 78a et seq. Table of Contents I. Introduction II. Final Amendments to Rule 506 and Form D A. Eliminating the Prohibition Against General Solicitation 1. Proposed Rule Amendment 2. Comments on the Proposed Rule Amendment 3. Final Rule Amendment B. Reasonable Steps To Verify Accredited Investor Status 1. Proposed Rule Amendment 2. Comments on the Proposed Rule Amendment 3. Final Rule Amendment a. Principles-Based Method of Verification b. Non-Exclusive Methods of Verifying Accredited Investor Status C. Reasonable Belief That All Purchasers Are Accredited Investors D. Form D Check Box for Rule 506(c) Offerings 1. Proposed Form Amendment 2. Comments on the Proposed Form Amendment 3. Final Form Amendment E. Specific Issues for Private Funds F. Technical and Conforming Amendments III. Final Amendment to Rule 144A IV. Integration With Offshore Offerings V. Paperwork Reduction Act A. Background B. Revisions to PRA Reporting and Cost Burden Estimates VI. Economic Analysis A. Background B. Economic Baseline 1. Size of the Exempt Offering Market 2. Affected Market Participants a. Issuers b. Investors c. Investment Advisers d. Broker-Dealers 3. Current Practices C. Analysis of the Amendment to Rule 506 1. Benefits to Issuers 2. Benefits to Investors 3. Costs 4. Indirect Effects on Other Markets 5. Retention of Rule 506(b) D. Verifying Accredited Investor Status in Rule 506(c) Offerings E. Analysis of the Amendment to Rule 144A F. Additional Information Collection and Disclosur es VII. Final Regulatory Flexibility Analysis A. Reasons for, and Objectives of, the Action B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Final Rule and Form Amendments D. Projected Reporting, Recordkeeping and Other Compliance Requirements E. Duplicative, Overlapping or Conflicting Federal Rules F. Significant Alternatives VIII. Statutory Authority and Text of Final Rule and Form Amendments I. Introduction On August 29, 2012, we proposed rule and form amendments 14 to implement Section 201(a) of the Jumpstart Our Business Startups Act (the “JOBS Act”). 15 Section 201(a)(1) of the JOBS Act directs the Commission, not later than 90 days after the date of enactment, to amend Rule 506 of Regulation D 16 under the Securities Act of 1933 (the “Securities Act”) to permit general solicitation or general advertising in offerings made under Rule 506, provided that all purchasers of the securities are accredited investors. 17 Section 201(a)(1) also states that “[s]uch rules shall 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.” Section 201(a)(2) of the JOBS Act directs the Commission, not later than 90 days after the date of enactment, to revise Rule 144A(d)(1) under the Securities Act 18 to permit offers of securities pursuant to Rule 144A to persons other than qualified institutional buyers (“QIBs”), 19 including by means of general solicitation or general advertising, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs. 14 See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-9354 (Aug. 29, 2012) [77 FR 54464 (Sept. 5, 2012)] (the “Proposing Release”). 15 Public Law 112-106, sec. 201(a), 126 Stat. 306, 313 (Apr. 5, 2012). 16 The Commission adopted Regulation D in 1982 as a result of the Commission's evaluation of the impact of its rules on the ability of small businesses to raise capital. See Revision of Certain Exemptions From Registration for Transactions Involving Limited Offers and Sales, Release No. 33-6389 (Mar. 8, 1982) [47 FR 11251 (Mar. 16, 1982)]. Over the years, the Commission has revised various provisions of Regulation D in order to address, among other things, specific concerns relating to facilitating capital-raising as well as abuses that have arisen under Regulation D. See, e.g., Additional Small Business Initiatives, Release No. 33-6996 (Apr. 28, 1993) [58 FR 26509 (May 4, 1993)] and Revision of Rule 504 of Regulation D, the “Seed Capital” Exemption, Release No. 33-7644 (Feb. 25, 1999) [64 FR 11090 (Mar. 8, 1999)]. 17 The definition of the term “accredited investor” that is applicable to Rule 506 is set forth in Rule 501(a) of Regulation D [17 CFR 230.501(a)] and includes any person who comes within one of the definition's enumerated categories of persons, or whom the issuer “reasonably believes” comes within any of the enumerated categories, at the time of the sale of the securities to that person. For natural persons, Rule 502(a) defines an accredited investor as a person: (1) Whose individual net worth, or joint net worth with that person's spouse, exceeds $1 million, excluding the value of the person's primary residence (the “net worth test”); or (2) who had an individual income in excess of $200,000 in each of the two most recent years, or joint income with that person's spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year (the “income test”). Although the Dodd-Frank Act did not change the amount of the $1 million net worth test, it did change how that amount is calculated—by excluding the value of a person's primary residence. This change took effect upon the enactment of the Dodd-Frank Act. In December 2011, we amended Rule 501 to incorporate this change into the definition of accredited investor. See Net Worth Standard for Accredited Investors, Release No. 33-9287 (Dec. 21, 2011) [76 FR 81793 (Dec. 29, 2011)]. 18 17 CFR 230.144A(d)(1). 19 The term “qualified institutional buyer” is defined in Rule 144A(a)(1) [17 CFR 230.144A(a)(1)] and includes specified institutions that, in the aggregate, own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with such institutions. Banks and other specified financial institutions must also have a net worth of at least $25 million. A registered broker-dealer qualifies as a QIB if it, in the aggregate, owns and invests on a discretionary basis at least $10 million in securities of issuers that are not affiliated with the broker-dealer. The Commission originally adopted Rule 506 as a non-exclusive safe harbor under Section 4(a)(2) (formerly Section 4(2)) of the Securities Act, 20 which exempts transactions by an issuer “not involving any public offering” from the registration requirements of Section 5 of the Securities Act. 21 Under existing Rule 506, an issuer may 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 who meet certain “sophistication” requirements. 22 The availability of Rule 506 is subject to a number of requirements 23 and is currently conditioned on the issuer, or any person acting on its behalf, not offering or selling securities through any form of “general solicitation or general advertising.” 24 Although the terms “general solicitation” and “general advertising” are not defined in Regulation D, Rule 502(c) does provide examples of general solicitation and general advertising, including advertisements published in newspapers and magazines, communications broadcast over television and radio, and seminars where attendees have been invited by general solicitation or general advertising. 25 By interpretation, the Commission has confirmed that other uses of publicly available media, such as unrestricted Web sites, also constitute general solicitation and general advertising. 26 In this release, we refer to both general solicitation and general advertising as “general solicitation.” 20 15 U.S.C. 77d(a)(2). 21 15 U.S.C. 77e. 22 Under Rule 506(b)(2)(ii) [17 CFR 230.506(b)(2)(ii)], each purchaser in a Rule 506 offering who is not an accredited investor must possess, or the issuer must reasonably believe immediately before the sale of securities that such purchaser possesses, either alone or with his or her purchaser representative, “such knowledge and experience in financial and business matters that he [or she] is capable of evaluating the merits and risks of the prospective investment.” 23 Offerings under Rule 506 are subject to all the terms and conditions of Rules 501 and 502. If securities are sold to any non-accredited investors, specified information requirements apply. See Rule 502(b) [17 CFR 230.502(b)]. 24 Rule 502(c) of Regulation D [17 CFR 230.502(c)]. 25 Id. 26 See Use of Electronic Media for Delivery Purposes, Release No. 33-7233 (Oct. 6, 1995) [60 FR 53458, 53463-64 (Oct. 13, 1995)]; Use of Electronic Media, Release No. 33-7856 (Apr. 28, 2000) [65 FR 25843, 25851-52 (May 4, 2000)]. Rule 144A is a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain “restricted securities” 27 to QIBs. Resales to QIBs in accordance with the conditions of Rule 144A 28 are exempt from registration pursuant to Section 4(a)(1) (formerly Section 4(1)) of the Securities Act, 29 which exempts transactions by any person “other than an issuer, underwriter, or dealer.” Although Rule 144A does not include an express prohibition against general solicitation, offers of securities under Rule 144A currently must be limited to QIBs, which has the same practical effect. By its terms, Rule 144A is available solely for resale transactions; however, since its adoption by the Commission in 1990, 30 market participants have used Rule 144A to facilitate capital-raising by issuers. 31 The term “Rule 144A offering” in this release refers to a primary offering of securities by an issuer to one or more financial intermediaries—commonly known as the “initial purchasers”—in a transaction that is exempt from registration pursuant to Section 4(a)(2) or Regulation S under the Securities Act, 32 followed by the resale of those securities by the initial purchasers to QIBs in reliance on Rule 144A. 27 “Restricted securities” are defined in Securities Act Rule 144(a)(3) [17 CFR 230.144(a)(3)] to include, in part, “[s]ecurities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering.” 28 In order for a transaction to come within existing Rule 144A, a seller must have a reasonable basis for believing that the offeree or purchaser is a QIB and must take reasonable steps to ensure that the purchaser is aware that the seller may rely on Rule 144A. Further, only securities that were not, when issued, of the same class as securities listed on a U.S. securities exchange or quoted on a U.S. automated interdealer quotation system are eligible for resale under Rule 144A. Also, the seller and a prospective purchaser designated by the seller must have the right to obtain from the issuer, upon request, certain information on the issuer, unless the issuer falls within specified categories as to which this condition does not apply. 29 15 U.S.C. 77d(a)(1). 30 See Resale of Restricted Securities; Changes to Method of Determining Holding Period of Restricted Securities Under Rules 144 and 145, Release No. 33-6862 (Apr. 23, 1990) [55 FR 17933 (Apr. 30, 1990)]. 31 While Rule 144A applies to resales of securities of both U.S. and non-U.S. issuers, one of the objectives of Rule 144A was to make primary offerings of non-U.S. issuers' securities available to U.S. institutions in the U.S. market through intermediaries (rather than compelling such investors to go to overseas markets) by making the private offering market in the United States more attractive to non-U.S. issuers. See Resale of Restricted Securities; Changes to Method of Determining Holding Period of Restricted Securities Under Rules 144 and 145, Release No. 33-6806 (Oct. 25, 1988) [53 FR 44016 (Nov. 1, 1988)]. 32 Regulation S under the Securities Act [17 CFR 230.901 through 230.905] was adopted in 1990 as a safe harbor from the registration requirements of the Securities Act for any offer or sale of securities made outside the United States. It provides that any “offer,” “offer to sell,” “sell,” “sale” or “offer to buy” that occurs outside the United States is not subject to the registration requirements of Section 5. Regulation S does not affect the scope or availability of the antifraud or other provisions of the Securities Act to offers and sales made in reliance on Regulation S. Rule 506 offerings and Rule 144A offerings are widely used by U.S. and non-U.S. issuers to raise capital. In 2012, the estimated amount of capital (including both equity and debt) reported as being raised in Rule 506 offerings and non-asset-backed securities (“non-ABS”) Rule 144A offerings by operating companies was $173 billion and $636 billion, respectively, and by pooled investment funds, such as venture capital funds, private equity funds and hedge funds, was $725 billion and $4 billion, respectively, compared to $1.2 trillion raised in registered offerings. 33 In 2011, the estimated amount of capital (including both equity and debt) reported as being raised in Rule 506 offerings and non-ABS Rule 144A offerings by operating companies was $71 billion and $438 billion, respectively, and by pooled investment funds was $778 billion and $4 billion, respectively, compared to $985 billion raised in registered offerings. 34 These data points underscore the importance of the Rule 506 and Rule 144A exemptions for issuers seeking access to the U.S. capital markets. 33 These statistics are based on a review of Form D electronic filings with the Commission—specifically, the “total amount sold” as reported in the filings—and data regarding other types of offerings ( e.g., public debt offerings and Rule 144A offerings) from Securities Data Corporation's New Issues database (Thomson Financial). See Vladimir Ivanov and Scott Bauguess, Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 2009-2012 (July 2013) (the “Ivanov/Bauguess Study”), available at: http://www.sec.gov/divisions/riskfin/whitepapers/dera-unregistered-offerings-reg-d.pdf . For non-ABS Rule 144A offerings, since the databases we used to obtain the Rule 144A data do not distinguish between operating companies and funds, we classified issuers with SIC codes between 6200 and 6299 as funds, and the rest as operating companies. The amount of capital raised through offerings under Regulation D may be larger than what is reported in Form D filings because, although the filing of a Form D is a requirement of Rule 503(a) of Regulation D [17 CFR 230.503(a)], it is not a condition to the availability of the exemptions under Regulation D. Further, once a Form D is filed, the issuer is not required to file an amendment to the filing to reflect a change that occurs after the offering terminates or a change that occurs solely with respect to certain information, such as the amount sold in the offering. For example, if the amount sold does not result in an increase in the total offering amount of more than 10% or the offering closes within a year, the filing of an amendment to the initial Form D is not required. Therefore, a Form D filed for a particular offering may not reflect the total amount of securities sold in the offering in reliance on the exemption. 34 See id. To implement Section 201(a) of the JOBS Act, we proposed amending Rule 506 to add new paragraph (c), under which the prohibition against general solicitation contained in Rule 502(c) would not apply, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that such purchasers are accredited investors. In addition, we proposed amending Form D, which is a notice required to be filed with the Commission by each issuer claiming a Regulation D exemption, to add a check box to indicate whether an issuer is claiming an exemption under Rule 506(c). We also proposed an amendment to 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 the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs. The comment period for the proposed rule and form amendments closed on October 5, 2012. We received over 225 comment letters on the Proposing Release, including from professional and trade associations, investor organizations, law firms, investment companies and investment advisers, members of Congress, the Commission's Investor Advisory Committee, 35 state securities regulators, issuers, individuals and other interested parties. Most of the comment letters focused on the proposed amendments to Rule 506. As discussed below, commenters were sharply divided in their views on the proposed amendments to Rule 506, whereas commenters generally supported the proposed amendments to Rule 144A and Form D. 35 The SEC Investor Advisory Committee (“Investor Advisory Committee”) was established in April 2012 pursuant to Section 911 of the Dodd-Frank Wall Street Reform and Consumer Protection Act [Pub. L. 111-203, sec. 911, 124 Stat. 1376, 1822 (July 21, 2010)] (the “Dodd-Frank Act”) to advise the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. The Dodd-Frank Act authorizes the Investor Advisory Committee to submit findings and recommendations for review and consideration by the Commission. We have reviewed and considered all of the comments that we received on the proposed rule and form amendments and on Section 201(a) of the JOBS Act. 36 We are adopting new paragraph (c) to Rule 506 as proposed, with one modification, and the amendments to Form D and to Rule 144A as proposed. We are also adopting the technical and conforming rule amendments as proposed. We discuss these amendments in detail below. 36 To facilitate public input on JOBS Act rulemaking before the issuance of rule proposals, the Commission invited members of the public to make their views known on various JOBS Act initiatives in advance of any rulemaking by submitting comment letters to the Commission's Web site at http://www.sec.gov/spotlight/jobsactcomments.shtml . The comment letters relating to Section 201(a) of the JOBS Act submitted in response to this invitation are located at http://www.sec.gov/comments/jobs-title-ii/jobs-title-ii.shtml . The comment letters submitted in response to the Proposing Release are located at http://www.sec.gov/comments/s7-07-12/s70712.shtml . Many commenters submitted comment letters both before and after the issuance of the Proposing Release. Dated comment letters refer to those submitted before the issuance of the Proposing Release or by commenters that submitted multiple letters. We acknowledge the concerns of some commenters that the elimination of the prohibition against general solicitation for a subset of Rule 506 offerings may affect the behavior of issuers and other market participants in ways they believe could compromise investor protection. 37 Preserving the integrity of the Rule 506(c) market and minimizing the incidence of fraud are critical objectives for the Commission in implementing Section 201(a) of the JOBS Act. We are adopting today the bad actor disqualification for Rule 506 offerings mandated by the Dodd-Frank Act, which may address some of those concerns. 38 We are also issuing a proposing release to amend Regulation D and Form D to enhance the Commission's ability to analyze the Rule 506 market and to amend Rule 156 under the Securities Act to provide guidance to private funds on the application of the antifraud provisions of the federal securities laws to their sales literature. 39 Upon the effectiveness of Rule 506(c), the Commission staff will monitor developments in the market for Rule 506(c) offerings so as to be able to undertake a review of market practices in Rule 506(c) offerings, including the steps taken by issuers and other market participants to verify that the purchasers of the offered securities are accredited investors, as well as the impact of the amendments to Rule 506 on capital formation. 37 See, e.g., letters from Investor Advisory Committee; North American Securities Administrators Association, Inc. (“NASAA”); Consumer Federation of America (“Consumer Federation”). 38 Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings, Release No. 33-9414 (July 10, 2013) (the “Bad Actor Release”). 39 See Amendments to Regulation D, Form D and Rule 156, Release No. 33-9416 (July 10, 2013). II. Final Amendments to Rule 506 and Form D A. Eliminating the Prohibition Against General Solicitation Section 4(a)(2) of the Securities Act exempts transactions by an issuer “not involving any public offering.” An issuer relying on Section 4(a)(2) is restricted in its ability to make public communications to attract investors for its offering because public advertising is incompatible with a claim of exemption under Section 4(a)(2). 40 As noted above, Rule 506 currently conditions the availability of the safe harbor under Section 4(a)(2) on the issuer, or any person acting on its behalf, not offering or selling securities through any form of general solicitation. 41 Section 201(a)(1) of the JOBS Act directs the Commission to amend Rule 506 to provide that the prohibition against general solicitation contained in Rule 502(c) shall not apply to offers and sales of securities made pursuant to Rule 506, as so amended, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify their status as accredited investors. 40 See Non-Public Offering Exemption, Release No. 33-4552 (Nov. 6, 1962) [27 FR 11316 (Nov. 16, 1962)]. 41 See Rule 502(c) and Rule 506(b)(1) of Regulation D [17 CFR 230.506(b)(1)]. The failure to comply with Rule 502(c) is deemed to be significant to the offering as a whole, which means that an issuer cannot rely on the “insignificant deviation” relief in Rule 508 of Regulation D for violations of Rule 502(c). See Rule 508(a)(2) [17 CFR 230.508(a)(2)]. This mandate affects only Rule 506, and not Section 4(a)(2) offerings in general, 42 which means that even after the effective date of Rule 506(c), an issuer relying on Section 4(a)(2) outside of the Rule 506(c) exemption will be restricted in its ability to make public communications to solicit investors for its offering because public advertising will continue to be incompatible with a claim of exemption under Section 4(a)(2). We are amending Rule 500(c) of Regulation D accordingly to make this clear. 43 Congress' directive in Section 201(a)(1) of the JOBS Act, and not Section 4(a)(2) of the Securities Act or our interpretation of Section 4(a)(2), is the reason that Rule 506, “as revised pursuant to [Section 201(a)(1)], shall continue to be treated as a regulation issued under section 4[(a)](2) of the Securities Act of 1933” (emphasis added). 44 Similarly, securities issued in Rule 506(c) offerings are deemed to be “covered securities” for purposes of Section 18(b)(4)(E) of the Securities Act, 45 only by virtue of Section 201(a)(1) of the JOBS Act. 42 In this regard, we also note that bills that would have amended Section 4(a)(2) directly, rather than requiring the Commission to amend Rule 506, to permit the use of general solicitation were introduced and considered by Congress, but were not enacted. See Access to Capital for Job Creators, H.R. 2940, 112th Cong., 1st Sess. (2011) (proposing to amend Section 4(a)(2) by adding the phrase “whether or not such transactions involve general solicitation or general advertising”); Access to Capital for Job Creators, S.1831, 112th Cong., 1st Sess. (2011) (same). 43 As revised, Rule 500(c) reads as follows: “Attempted compliance with any rule in Regulation D does not act as an exclusive election; the issuer can also claim the availability of any other applicable exemption. For instance, an issuer's failure to satisfy all the terms and conditions of rule 506 (b) (§ 230.506 (b) ) shall not raise any presumption that the exemption provided by section 4 (a) (2) of the Act is not available.” (additions italicized). 44 Section 201(a)(1) of the JOBS Act. 45 15 U.S.C. 77r(b)(4)(E). This means that state blue sky registration requirements do not apply to securities offered or sold in Rule 506(c) offerings. 1. Proposed Rule Amendment To implement the mandated rule change, we proposed new Rule 506(c), which would permit the use of general solicitation to offer and sell securities under Rule 506, provided that the following conditions are satisfied: • All terms and conditions of Rule 501 46 and Rules 502(a) 47 and 502(d) 48 must be satisfied; 46 Rule 501 sets forth definitions for the terms used in Regulation D, such as “accredited investor.” 47 Rule 502(a) addresses the question of integration by providing a six-month safe harbor from integration for successive Regulation D offerings and a five-factor framework to apply in cases in which the six-month safe harbor is not available. 48 Rule 502(d) provides that, for resale purposes, securities acquired in a Regulation D offering, except as provided in Rule 504(b)(1), have the status of securities acquired in a transaction under Section 4(a)(2) of the Securities Act. Rule 144(a)(3)(ii) [17 CFR 230.144(a)(3)(ii)] defines “restricted securities” as securities “acquired from the issuer that are subject to the resale limitations of § 230.502(d) under Regulation D. . . .” Separately, Section 201(b) of the JOBS Act added Section 4(b) of the Securities Act, which provides that “[o]ffers and sales exempt under [Rule 506 as amended pursuant to Section 201 of the JOBS Act] shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” Thus, securities acquired under new Rule 506(c) would also meet the definition of “restricted securities” under Rule 144(a)(3)(i) [17 CFR 230.144(a)(3)(i)] (“[s]ecurities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering”). • all purchasers of securities must be accredited investors; and • the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors. Offerings under proposed Rule 506(c) would not be subject to the requirement to comply with Rule 502(c), which contains the prohibition against general solicitation. While we proposed Rule 506(c) to enable issuers to use general solicitation in Rule 506 offerings, we also preserved, in current Rule 506(b), the existing ability of issuers to conduct Rule 506 offerings subject to the prohibition against general solicitation. 2. Comments on the Proposed Rule Amendment Commenters were sharply divided in their views on the proposed amendment to Rule 506. Commenters who supported the proposed amendment to Rule 506 stated that Rule 506(c), if adopted, would assist issuers, particularly early stage and smaller issuers, in raising capital by allowing them to solicit investments from a larger pool of investors. 49 These commenters generally approved of the flexibility afforded by the manner in which we proposed to implement Rule 506(c)'s verification requirement, 50 as further discussed below, and supported retaining, in its current form, the ability of issuers under existing Rule 506(b) to conduct Rule 506 offerings subject to the prohibition against general solicitation. 51 A number of commenters stated that they supported the availability of Rule 506(c) for private funds pursuant to the Commission's guidance in the Proposing Release. 52 49 See, e.g., letters from Biotechnology Industry Organization (“BIO”); National Small Business Association (“NSBA”). 50 See letters from Linklaters LLP (“Linklaters”) (stating that a “straightforward, focused rule that provides issuers with the flexibility to continue to adapt to market practice is the best way to realize the spirit and intent of the Jumpstart Our Business Startups Act”); BlackRock (stating that “[o]verall, we believe that the Proposed Rule is in accordance with the intent of Congress and will facilitate the formation of capital”); Securities Regulation Committee, Business Law Section of the New York State Bar Association (“SRC of NYSBA”). 51 See, e.g., letters from the Federal Regulation of Securities Committee, Business Law Section of the American Bar Association (“ABA Fed. Reg. Comm.”); Angel Capital Association (“ACA”) (Sept. 27, 2012); The CrowdFund Intermediary Regulatory Advocates (“CFIRA”); Investment Program Association (“IPA”); Montgomery & Hansen, LLP (“Montgomery & Hansen”); NSBA; Committee on Securities Regulation of the New York City Bar Association (“NYCBA”); Sullivan & Cromwell LLP (“S&C”); Securities Industry and Financial Markets Association (“SIFMA”) and The Financial Services Roundtable (“FSR”) (Oct. 5, 2012). 52 See, e.g., letters from BlackRock; Dukas Public Relations (“Dukas”); Forum for U.S. Securities Lawyers in London; Hedge Fund Association (“HFA”); Investment Adviser Association (“IAA”); Managed Funds Association (“MFA”) (Sept. 28, 2012); NYCBA; SRC of NYSBA. In the Proposing Release, we stated that private funds that engage in general solicitation under proposed Rule 506(c) would not be precluded from relying on the exclusions from the definition of “investment company” set forth in Section 3(c)(1) and Section 3(c)(7) of the Investment Company Act of 1940. Other commenters opposed the proposed amendment to Rule 506 in its entirety or in part. Many of these commenters expressed concern that the proposed amendment, if adopted, would increase the risk of fraudulent and abusive Rule 506 offerings and asserted that additional investor safeguards are necessary under Rule 506(c). 53 A number of these commenters urged the Commission to adopt rules concerning bad actor disqualifications for Rule 506 offerings, as required by Section 926 of the Dodd-Frank Act. 54 Other commenters recommended that the Commission amend the definition of “accredited investor” by raising the income and net worth thresholds for natural persons or by implementing other measures of financial sophistication. 55 Some commenters stated that the Commission should condition the availability of the Rule 506(c) exemption on the filing of Form D or require the advance filing of Form D, or both. 56 Other commenters argued that the Commission should adopt specific standards or requirements that would govern the content and/or manner of general solicitations in Rule 506(c) offerings, particularly with respect to advertising by private funds. 57 A number of commenters urged the Commission to require that the materials used to generally solicit investors in Rule 506(c) offerings be filed with or furnished to either the Commission or to FINRA. 58 53 See, e.g., letters from AARP; AFL-CIO and Americans for Financial Reform (“AFR”); Sen. Levin; CFA Institute; Council of Institutional Investors (“CII”); Consumer Federation; Fund Democracy, Inc. (“Fund Democracy”); Office of the Secretary of the Commonwealth of Massachusetts Securities Division (“Massachusetts Securities Division”); NASAA. 54 Public Law 111-203, sec. 926, 124 Stat. 1376, 1851 (July 21, 2010) (to be codified at 15 U.S.C. 77d note). See, e.g., letters from AFL-CIO and AFR; Consumer Federation; Fund Democracy; Commissioner of Securities, State of Hawaii (“Hawaii Commissioner of Securities”); Investor Advisory Committee; Rep. Waters; Commissioner of Securities, State of Missouri (“Missouri Commissioner of Securities”); NASAA. 55 See, e.g., letters from AARP; AFL-CIO and AFR; BetterInvesting; CFA Institute; Consumer Federation; Investor Advisory Committee; Investment Company Institute (“ICI”); Rep. Waters; Massachusetts Securities Division (July 2, 2012). 56 See, e.g., letters from AARP; AFL-CIO and AFR; Consumer Federation; Hawaii Commissioner of Securities; Investor Advisory Committee; Massachusetts Securities Division (July 2, 2012); Missouri Commissioner of Securities; Commissioner of Securities and Insurance, State of Montana (“Montana Commissioner of Securities”); NASAA; Ohio Division of Securities. 57 See, e.g., letters from Sen. Levin; Consumer Federation; ICI; Independent Directors Council (“IDC”); Rep. Waters; Montana Commissioner of Securities; NASAA. 58 See, e.g., letters from AFL-CIO and AFR; Investor Advisory Committee; ICI; Massachusetts Securities Division (July 2, 2012). A number of commenters requested that the Commission provide transitional guidance with respect to ongoing offerings under existing Rule 506 that commenced before the effectiveness of Rule 506(c). 59 For example, in some situations, the initial closings in these offerings may have already occurred, and could have included non-accredited investors pursuant to offering procedures that would not have involved any form of general solicitation. 60 Several commenters suggested that the Commission clarify that an issuer would be entitled to conduct the portion of the offering following the effectiveness of Rule 506(c) in accordance with the requirements of new Rule 506(c), without the portion of the offering occurring after the rule's effectiveness affecting the portion of the offering that was completed prior to the rule's effectiveness. 61 59 See letters from ABA Fed. Reg. Comm.; Forum for U.S. Securities Lawyers in London; S&C; IPA. 60 See letter from ABA Fed. Reg. Comm. 61 See letters from ABA Fed. Reg. Comm.; S&C (stating that “[w]e believe that such issuers should be allowed, upon effectiveness of the final rule, to use the new Rule 506(c) exemption and use general solicitation for the remaining portion of their offerings, provided that they satisfy the requirements of Rule 506(c) going forward.”). 3. Final Rule Amendment After considering the comments, we are adopting Rule 506(c) as proposed, with one modification. Under new Rule 506(c), issuers can offer securities through means of general solicitation, provided that they satisfy all of the conditions of the exemption. 62 These conditions are: 62 We also note that broker-dealers participating in offerings in conjunction with issuers relying on Rule 506(c) would continue to be subject to FINRA rules regarding communications with the public, which, among other things, (1) generally require all member communications to be based on principles of fair dealing and good faith, to be fair and balanced, and to provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry or service; and (2) prohibit broker-dealers from making false, exaggerated, unwarranted, promissory or misleading statements or claims in any communications. See FINRA Rule 2210. • all terms and conditions of Rule 501 and Rules 502(a) and 502(d) must be satisfied; 63 63 New Rule 506(c)(1). • all purchasers of securities must be accredited investors; 64 and 64 New Rule 506(c)(2)(i). • the issuer must take reasonable steps to verify that the purchasers of the securities are accredited investors. 65 65 New Rule 506(c)(2)(ii). Issuers relying on Rule 506(c) for their offerings will not be subject to the prohibition against general solicitation found in Rule 502(c). 66 In addition and as further discussed below, in response to comments from a wide range of commenters asking for greater certainty with respect to satisfying the verification requirement, we are also including in Rule 506(c) a non-exclusive list of methods that issuers may use to verify the accredited investor status of natural persons. 66 Offerings under Rule 506(c) will also not be subject to the information requirements in Rule 502(b) for non-accredited investors, because all purchasers in Rule 506(c) offerings are required to be accredited investors. Issuers will continue to have the ability under Rule 506(b) to conduct Rule 506 offerings subject to the prohibition against general solicitation. As we noted in the Proposing Release, offerings under existing Rule 506(b) represent an important source of capital for issuers of all sizes, and we believe that the continued availability of existing Rule 506(b) will be important for those issuers that either do not wish to engage in general solicitation in their Rule 506 offerings (and become subject to the requirement to take reasonable steps to verify the accredited investor status of purchasers) or wish to sell privately to non-accredited investors who meet Rule 506(b)'s sophistication requirements. Retaining the safe harbor under existing Rule 506(b) may also be beneficial to investors with whom an issuer has a pre-existing substantive relationship. 67 In this regard, we do not believe that Section 201(a) requires the Commission to modify Rule 506 to impose any new requirements on offers and sales of securities that do not involve general solicitation. Therefore, the amendment to Rule 506 we are adopting today does not amend or modify the requirements relating to existing Rule 506(b). 67 See Release No. 33-7856, at 25852 (noting that “one method of ensuring that general solicitation is not involved is to establish the existence of a `pre-existing, substantive relationship'” and that “there may be facts and circumstances in which a third party, other than a registered broker-dealer, could established a `pre-existing, substantive relationship' sufficient to avoid a `general solicitation' ”). Finally, with respect to transition matters, for an ongoing offering under Rule 506 that commenced before the effective date of Rule 506(c), the issuer may choose to continue the offering after the effective date in accordance with the requirements of either Rule 506(b) or Rule 506(c). If an issuer chooses to continue the offering in accordance with the requirements of Rule 506(c), any general solicitation that occurs after the effective date will not affect the exempt status of offers and sales of securities that occurred prior to the effective date in reliance on Rule 506(b). B. Reasonable Steps To Verify Accredited Investor Status Section 201(a)(1) of the JOBS Act mandates that our amendment to Rule 506 require issuers using general solicitation in Rule 506 offerings “to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.” As noted in the Proposing Release, we believe that the purpose of the verification mandate is to address concerns, and reduce the risk, that the use of general solicitation in Rule 506 offerings could result in sales of securities to investors who are not, in fact, accredited investors. 68 68 See, e.g., Markup of H.R. 2940, Access to Capital for Job Creators Act, Subcommittee on Capital Markets and Government Sponsored Enterprises, House Financial Services Committee, 112th Cong. (Oct. 5, 2011) (remarks of Rep. Waters, explaining that she is introducing the amendment that requires issuers to take reasonable steps to verify accredited investor status because “we must take steps to ensure that those folks are indeed sophisticated”); 157 Cong. Rec. H7291 (daily ed. Nov. 3, 2011) (remarks of Rep. Maloney (same)); 157 Cong. Rec. H7294 (daily ed. Nov. 3, 2011) (remarks of Rep. Lee (same)). 1. Proposed Rule Amendment To implement the verification mandate of Section 201(a)(1), we proposed to condition the Rule 506(c) exemption on the requirement that issuers using general solicitation “take reasonable steps to verify” that the purchasers of the offered securities are accredited investors. As proposed, whether the steps taken are “reasonable” would be an objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction. Under this principles-based approach, issuers would consider a number of factors when determining the reasonableness of the steps to verify that a purchaser is an accredited investor, such as: • 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. These factors would be interconnected, and the information gained by looking at these factors would help an issuer assess the reasonable likelihood that a potential purchaser is an accredited investor, which would, in turn, affect the types of steps that would be reasonable to take to verify a purchaser's accredited investor status. In the Proposing Release, we considered providing a list of specified methods for satisfying the verification requirement, which was suggested by some commenters on Section 201(a) prior to the issuance of the Proposing Release. 69 We expressed concern that, in designating such a list—for example, by setting forth particular types of information that issuers may rely upon as conclusive means of verifying accredited investor status—there may be circumstances where such information will not actually verify accredited investor status or where issuers may unreasonably overlook or disregard other information indicating that a purchaser is not, in fact, an accredited investor. Also, we were concerned that requiring issuers to use specified methods of verification would be impractical, burdensome and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor, as well as the potentially wide range of verification issues that may arise, depending on the nature of the purchaser and the facts and circumstances of a particular Rule 506(c) offering. Even if the list of specified methods was not mandatory, but rather, constituted a non-exclusive list, we were concerned that a non-exclusive list of specified methods could be viewed by market participants as, in effect, required methods, in which compliance with at least one of the enumerated methods could be viewed as necessary in all circumstances to demonstrate that the verification requirement has been satisfied, thereby eliminating the flexibility that proposed Rule 506(c) was intended to provide. 69 See letters from MFA (June 26, 2012) (suggesting that the Commission publish a non-exclusive list of the types of third-party evidence that an investor could provide to establish accredited investor status, in conjunction with certifying that he or she is an accredited investor); NASAA (July 3, 2012) (recommending that the Commission set forth non-exclusive safe harbors to specify the types of actions that would be deemed “reasonable steps to verify” for three types of accredited investors: natural persons who purport to satisfy the income test; natural persons who purport to satisfy the net worth test; and entities who purport to meet one of the other tests set forth in Rule 501(a)). We requested comment in the Proposing Release on our proposed principles-based method and its effectiveness in limiting sales of securities in Rule 506(c) offerings to only accredited investors. We also requested comment on possible alternative approaches for implementing the verification mandate of Section 201(a)(1), such as a rule that specifies mandatory methods for verifying accredited investor status or a non-exclusive list of verification methods that would function as a safe harbor for compliance with the verification requirement. 2. Comments on the Proposed Rule Amendment Commenters expressed a wide range of views on the proposed approach to the verification requirement in Rule 506(c). Some commenters commended the Commission for proposing a flexible, principles-based standard for verification. 70 For example, one commenter stated that the Commission's proposed approach would provide issuers with the flexibility to develop tailored, reliable and cost-effective procedures for verification. 71 A number of commenters stated that the discussion in the Proposing Release of the factors that issuers may take into account in verifying accredited investor status would assist issuers in assessing the reasonableness of their verification processes. 72 Other commenters asserted that not requiring issuers to use certain specified methods to verify a purchaser's accredited investor status would permit advancements in verification methods over time. 73 Some commenters expressed support for the Commission's proposal that accredited investor status may be verified through an attestation or certification by a third party, provided that the issuer has a reasonable basis to rely on such third-party verification. 74 70 See, e.g., letters from HFA; MFA (Sept. 28, 2012); BIO; ABA Fed. Reg. Comm.; IAA; Linklaters; NYCBA; SRC of NYSBA; SIFMA and FSR (Oct. 5, 2012); Artivest Holdings, Inc. (“Artivest”). 71 See letter from SIFMA and FSR (Oct. 5, 2012). 72 See, e.g., letters from SRC of NYSBA; S&C; SIFMA and FSR (Oct. 5, 2012); IAA. 73 See letters from ACA (Sept. 27, 2012); CFIRA. 74 See, e.g., letters from IAA; SIFMA and FSR (Oct. 5, 2012); Tannenbaum Helpern Syracuse & Hirschtritt LLP (“Tannenbaum Helpern”). A number of commenters noted that the availability of third-party verification could address investors' privacy and security concerns in providing information to an issuer. See, e.g., letters from L. Neumann; NSBA. One commenter urged the Commission not to limit third-party verification providers to certain types of entities. See letter from Tannenbaum Helpern. One commenter suggested the possibility of requiring investors to self-certify as to accredited investor status under penalty of perjury. See letter from NSBA. Other commenters opposed the Commission's proposed approach, for various reasons. A number of these commenters opposed the proposed verification standard because, in their view, self-certification by itself should be sufficient to satisfy the verification requirement. 75 Some commenters opposed the proposed verification standard because it did not prescribe specific verification methods, which they believed is required in order to satisfy the verification mandate in Section 201(a). 76 One commenter stated that the Commission should deem the verification requirement to be satisfied if all purchasers in a Rule 506(c) offering are in fact accredited investors. 77 Another commenter stated that verification of accredited investor status should not be a condition of the Rule 506(c) exemption when the purchaser is actually an accredited investor. 78 75 See, e.g., letters from C. Hague; G. Brooks; Golenbock Eiseman Assor Bell & Peskoe LLP; P. Christenson; W. Johnson. 76 See, e.g., letters from AFL-CIO and AFR; Sen. Levin; Consumer Federation; Fund Democracy; Rep. Waters; Massachusetts Securities Division; The Options Clearing Corporation (“OCC”); Ohio Division of Securities. 77 See letter from IPA. 78 See letter from S. Keller. Commenters expressed differing views on whether the Commission should include a non-exclusive list of methods in proposed Rule 506(c) for satisfying the verification requirement. Many commenters, encompassing a wide range of perspectives ( e.g., state government officials, law firms, investor organizations, professional and trade associations, and individuals), urged the Commission to provide such a non-exclusive list. 79 A number of these commenters cited the lack of legal certainty that the verification requirement has been satisfied in any given situation as the reason why, in their view, the Commission should include a non-exclusive list of verification methods in Rule 506(c). 80 In contrast, other commenters stated that the Commission should not include a non-exclusive list of verification methods in Rule 506(c), arguing that such a list could be viewed by market participants as the required verification methods, which would thereby undermine the flexibility of the Commission's proposed approach. 81 79 See, e.g., letters from ACA (Sept. 27, 2012 and Dec. 11, 2012); BIO; CFIRA; HFA; Hawaii Commissioner of Securities; IAA; Investor Advisory Committee (stating that the “facts and circumstances” based approach proposed by the Commission does not do enough either to ensure only accredited investors purchase in the offering or to provide issuers with the certainty they need to develop appropriate procedures); J. McLaughlin; MFA (Sept. 28, 2012); Montana Commissioner of Securities; NASAA; Tufts Stephenson & Kasper, LLP; Nevada Securities Division; OCC; Ohio Division of Securities; Pepper Hamilton LLP (“Pepper Hamilton”); Plexus Consulting Group, LLC (“Plexus Consulting Group”); Small Business Investor Association (“SBIA”); South Carolina Securities Commissioner; Virginia Division of Securities. 80 See, e.g., letters from ACA (Sept. 27, 2012 and Dec. 11, 2012); HFA; Investor Advisory Committee; OCC. 81 See, e.g., letters from ABA Fed. Reg. Comm.; Artivest; BlackRock; S&C; SIFMA and FSR (Oct. 5, 2012). If there were to be a non-exclusive list of verification methods, commenters expressed a range of views on what should be included in such a list, such as verification by certain third parties or through tax returns and third-party documentary proof such as Forms W-2, Forms 1099, bank statements, brokerage account statements, tax assessment valuations and appraisal reports. 82 With respect to the types of third parties that could provide verification services, commenters named registered brokers-dealers, 83 banks and other financial institutions, 84 registered investment advisers, 85 certified financial planners, 86 attorneys, 87 and accountants. 88 Other commenters suggested including in a non-exclusive list of verification methods self-certification, plus a minimum investment amount such as $25,000, 89 $100,000, 90 $250,000, 91 $500,000 92 or $1,000,000. 93 82 See, e.g., letters from B. Methven; L. Neumann; NASAA. 83 See, e.g., letters from Massachusetts Securities Division (July 2, 2012); J. McLaughlin; NASAA; OCC; Pepper Hamilton; Plexus Consulting Group; SBIA. 84 See letter from Massachusetts Securities Division (July 2, 2012). 85 See, e.g., letters from Plexus Consulting Group; SBIA. 86 See, e.g., letters from Plexus Consulting Group; NSBA (stating that “if there must be some kind of enhanced verification, we recommend that a certification by the investor's attorney, CPA, certified financial advisor or other licensed professional should be sufficient”). 87 Id. 88 Id. 89 See letter from Montgomery & Hansen. 90 See letters from B. Methven; SBIA (provided the issuer is a small business investment company (“SBIC”) or a fund that has been authorized to apply to be an SBIC by the U.S. Small Business Administration). 91 See letter from J. Joseph (stating that “[s]ome may feel that that number is $25,000, perhaps $100,000 but certainly at $250,000 there should be no question that the investor is properly qualified and accredited”). 92 See letter from MFA (Sept. 28, 2012) (stating that “[i]n considering the appropriate minimum investment level, we have previously recommended a minimum investment level of 50% of the accredited investor net worth or total asset thresholds, currently $500,000 for an individual, and $2,500,000 for an entity”). 93 See letter from Pepper Hamilton. In contrast, one commenter argued that the ability to satisfy a minimum investment amount would not necessarily mean a person is an accredited investor, but rather, that the investor could be “over-concentrated in the investment.” 94 Another commenter stated that the verification requirement should not be deemed satisfied simply because an issuer possesses general information about the average compensation in the investor's profession or workplace. 95 94 Letter from Massachusetts Securities Division (July 2, 2012). 95 See letter from NASAA. Several commenters stated that there should be a “grandfather” provision from the verification mandate for an issuer's existing investors who purchased securities in a Rule 506(b) offering prior to the effective date of Rule 506(c), 96 and one commenter proposed to limit the scope of any grandfather provision to only existing accredited investors. 97 Two of these commenters reasoned that, as issuers are prohibited from engaging in general solicitation activities in Rule 506(b) offerings, their existing investors did not purchase securities in offerings that used general solicitation, and any future investments by these investors would be based on their pre-existing relationship with the issuers, and not as a result of general solicitation. 98 Therefore, a grandfather provision would be appropriate because the purpose of the verification mandate in Section 201(a) of the JOBS Act is to require the verification of the accredited investor status of only prospective purchasers who come to the issuer “as a result of” the issuer's general solicitation activities. 99 One commenter stated that, for existing investors, a “reaffirmation representation” of accredited investor status received shortly before or simultaneously with any subsequent investment should be sufficient for Rule 506(c) purposes. 100 96 See letters from MFA (Sept. 28, 2012); IAA; Tannenbaum Helpern. 97 See letter from Pepper Hamilton. 98 See letters from MFA (Sept. 28, 2012); Tannenbaum Helpern. 99 See letter from Tannenbaum Helpern. 100 See letter from Pepper Hamilton. 3. Final Rule Amendment After considering the comments and as directed by Section 201(a) of the JOBS Act, we are adopting as a condition of new Rule 506(c) the requirement that issuers take “reasonable steps to verify” that purchasers of the offered securities are accredited investors. This requirement is separate from and independent of the requirement that sales be limited to accredited investors, and must be satisfied even if all purchasers happen to be accredited investors. 101 We are also including in Rule 506(c) a non-exclusive list of methods that issuers may use to satisfy the verification requirement. As discussed above, a number of commenters urged the Commission to provide greater certainty for issuers that the verification requirement has been satisfied by providing a non-exclusive list of methods for verifying the accredited investor status of purchasers in Rule 506(c) offerings. Upon further consideration, we have concluded that a general requirement that issuers take “reasonable steps to verify” that the purchasers are accredited investors, combined with a non-exclusive list of verification methods that are deemed to meet this requirement, would maintain the flexibility of the verification standard while providing additional clarity and certainty that this requirement has been satisfied if one of the specified methods is used. We have specified methods for verifying the accredited investor status of natural persons because we believe that the potential for uncertainty and the risk of participation by non-accredited investors is highest in offerings involving natural persons as purchasers. 101 This will avoid diminishing the incentive for issuers to undertake the reasonable verification steps envisioned by the statute. a. Principles-Based Method of Verification Under Rule 506(c), issuers are required to take reasonable steps to verify the accredited investor status of purchasers. Consistent with the Proposing Release, whether the steps taken are “reasonable” will be an objective determination by the issuer (or those acting on its behalf), in the context of the particular facts and circumstances of each purchaser and transaction. Among the factors that issuers should consider under this facts and circumstances analysis 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. As noted in the Proposing Release, these factors are interconnected and are intended to help guide an issuer in assessing the reasonable likelihood that a purchaser is an accredited investor—which would, in turn, affect the types of steps that would be reasonable to take to verify a purchaser's accredited investor status. After consideration of the facts and circumstances of the purchaser and of the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify accredited investor status, and vice versa. For example, if the terms of the offering require a high minimum investment amount and a purchaser is able to meet those terms, then the likelihood of that purchaser satisfying the definition of accredited investor may be sufficiently high such that, absent any facts that indicate that the purchaser is not an accredited investor, it may be reasonable for the issuer to take fewer steps to verify or, in certain cases, no additional steps to verify accredited investor status other than to confirm that the purchaser's cash investment is not being financed by a third party. Regardless of the particular steps taken, because the issuer has the burden of demonstrating that its offering is entitled to an exemption from the registration requirements of Section 5 of the Securities Act, 102 it will be important for issuers and their verification service providers to retain adequate records regarding the steps taken to verify that a purchaser was an accredited investor. 102 SEC v. Ralston Purina, 346 U.S. 119, 126 (1953) (“Keeping in mind the broadly remedial purposes of federal securities legislation, imposition of the burden of proof on an issuer who would plead the exemption seems to us fair and reasonable.”). Nature of the Purchaser. In determining the reasonableness of the steps to verify accredited investor status, an issuer should consider the nature of the purchaser of the offered securities. The definition of “accredited investor” in Rule 501(a) includes natural persons and entities that come within any of eight enumerated categories in the rule, or that the issuer reasonably believes come within one of those categories, at the time of the sale of securities to that natural person or entity. Some purchasers may be accredited investors based on their status, such as: • a broker or dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”); 103 or 103 See 17 CFR 230.501(a)(1). • an investment company registered under the Investment Company Act of 1940 (the “Investment Company Act”) or a business development company as defined in Section 2(a)(48) of that Act. 104 104 See id. Some purchasers may be accredited investors based on a combination of their status and the amount of their total assets, such as: • a plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5 million; 105 or 105 See id. • an Internal Revenue Code (“IRC”) Section 501(c)(3) organization, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5 million. 106 106 See 17 CFR 230.501(a)(3). Natural persons may be accredited investors based on either their net worth or their annual income, as follows: • a natural person whose individual net worth, or joint net worth with that person's spouse, exceeds $1 million, excluding the value of the person's primary residence; 107 or 107 See 17 CFR 230.501(a)(5). • a natural person who had an individual income in excess of $200,000 in each of the two most recent years, or joint income with that person's spouse in excess of $300,000 in each of those years, and has a reasonable expectation of reaching the same income level in the current year. 108 108 See 17 CFR 230.501(a)(6). As Rule 501(a) sets forth different categories of accredited investors, an issuer should recognize that the steps that will be reasonable to verify whether a purchaser is an accredited investor will vary depending on the type of accredited investor that the purchaser claims to be. For example, the steps that may be reasonable to verify that an entity is an accredited investor by virtue of being a registered broker-dealer—such as by going to FINRA's BrokerCheck Web site 109 —will necessarily differ from the steps that may be reasonable to verify whether a natural person is an accredited investor. 109 This Web site is available at: http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/ . As we stated in the Proposing Release, the verification of natural persons as accredited investors may pose greater practical difficulties as compared to other categories of accredited investors, particularly for natural persons claiming to be accredited investors based on the net worth test. These practical difficulties likely will be exacerbated by privacy concerns about the disclosure of personal financial information. As between the net worth test and the income test for natural persons, we recognize that commenters have suggested that it might be more difficult for an issuer to obtain information about the assets and liabilities that determine a person's net worth—particularly the liabilities—than it would be to obtain information about a person's annual income, 110 although there could be privacy concerns with respect to either test. The question of what type of information would be sufficient to constitute reasonable steps to verify accredited investor status under the particular facts and circumstances will also depend on other factors, as described below. 110 See letters from NASAA (stating that “[v]erification of net worth is more challenging because an individual could provide proof of assets but not liabilities.”); P. Sigelman (Sept. 28, 2012). Information about the Purchaser. The amount and type of information that an issuer has about a purchaser can also be a significant factor in determining what additional steps would be reasonable to take to verify the purchaser's accredited investor status. The more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it may have to take, and vice versa. 111 Examples of the types of information that issuers could review or rely upon—any of which might, depending on the circumstances, in and of themselves constitute reasonable steps to verify a purchaser's accredited investor status—include, without limitation: 111 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. • publicly available information in filings with a federal, state or local regulatory body—for example, without limitation: ○ the purchaser is a named executive officer of an Exchange Act registrant, and the registrant's proxy statement discloses the purchaser's compensation; or ○ the purchaser claims to be an IRC Section 501(c)(3) organization with $5 million in assets, and the organization's Form 990 series return filed with the Internal Revenue Service discloses the organization's total assets; 112 112 Such an organization is required to make the Form 990 series returns available for public inspection. See Internal Revenue Service, Public Disclosure and Availability of Exempt Organizations Returns and Applications: Documents Subject to Public Disclosure, available at: http://www.irs.gov/Charities-&-Non-Profits/Public-Disclosure-and-Availability-of-Exempt-Organizations-Returns-and-Applications:-Documents-Subject-to-Public-Disclosure (last reviewed or updated April 28, 2013). • third-party information that provides reasonably reliable evidence that a person falls within one of the enumerated categories in the accredited investor definition—for example, without limitation: ○ the purchaser is a natural person and provides copies of pay stubs for the two most recent years and the current year; or ○ specific information about the average compensation earned at the purchaser's workplace by persons at the level of the purchaser's seniority is publicly available; or • verification of a person's status as an accredited investor by a third party, provided that the issuer has a reasonable basis to rely on such third-party verification. 113 113 For example, in the future, services may develop that verify a person's accredited investor status for purposes of new Rule 506(c) and permit issuers to check the accredited investor status of possible investors, particularly for web-based Rule 506 offering portals that include offerings for multiple issuers. This third-party service, as opposed to the issuer itself, could obtain appropriate documentation or otherwise take reasonable steps to verify accredited investor status. Several commenters, in fact, have recommended that the Commission take action to facilitate the ability of issuers to rely on third parties to perform the necessary verification. See letters from NASAA (July 3, 2012) (recommending that the Commission allow an issuer to obtain the necessary verification through registered broker-dealers, provided that there are independent liability provisions for failure to adequately perform the verification); Massachusetts Securities Division (July 2, 2012) (urging the Commission to adopt as a safe harbor or best practice the use of an independent party, such as a broker-dealer, bank, or other financial institution, that would verify the accredited investor status of purchasers). One commenter, however, expressed concerns that some of the Web sites that currently offer lists of accredited investors could be used to facilitate fraud, noting that some offer lists based on “ethnicity, gender, and lifestyle—presumably to make [it] easier for scammers to relate to marks—and ominously, `seniors.' ” Letter from I. Moscovitz and J. Maxfield (June 27, 2012). Nature and Terms of the Offering. The nature of the offering—such as the means through which the issuer publicly solicits purchasers—may be relevant in determining the reasonableness of the steps taken to verify accredited investor status. An issuer that solicits new investors through a Web site accessible to the general public, through a widely disseminated email or social media solicitation, or through print media, such as a newspaper, will likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party. We believe that an issuer will be entitled to rely on a third party that has verified a person's status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification. We do not believe that an issuer will have taken reasonable steps to verify accredited investor status if it, or those acting on its behalf, required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status. The terms of the offering will also affect whether the verification methods used by the issuer are reasonable. We continue to believe that there is merit to the view that a purchaser's ability to meet a high minimum investment amount could be a relevant factor to the issuer's evaluation of the types of steps that would be reasonable to take in order to verify that purchaser's status as an accredited investor. By way of example, the ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors could reasonably be expected to meet it, with a direct cash investment that is not financed by the issuer or by any third party, could be taken into consideration in verifying accredited investor status. Commenters suggested a number of alternative approaches to implementing the verification mandate. Some commenters urged us to adopt a requirement that prescribes specific methods of verification that issuers must use, either because they believed such methods are needed for issuers seeking clarity on how to comply with this condition of Rule 506(c) 114 or because they believed that such methods are needed to maintain investor protection. 115 We have decided not to take such an approach. As we stated in the Proposing Release, we believe that, at present, requiring issuers to use specified methods of verification will be impractical and potentially ineffective in light of the numerous ways in which a purchaser can qualify as an accredited investor, as well as the potentially wide range of verification issues that may arise, depending on the nature of the purchaser and the facts and circumstances of a particular Rule 506(c) offering. We are also concerned that a prescriptive rule that specifies required verification methods could be overly burdensome in some cases, by requiring issuers to follow the same steps, regardless of their particular circumstances, and ineffective in others, by requiring steps that, in the particular circumstances, would not actually verify accredited investor status. 114 See, e.g., letter from Handler Thayer, LLP. 115 See, e.g., letters from AARP; CII. We believe that the approach we are adopting appropriately addresses the concerns underlying the verification mandate by obligating issuers to take reasonable steps to verify that the purchasers are accredited investors, but not requiring them to follow uniform verification methods that may be ill-suited or unnecessary to a particular offering or purchaser in light of the facts and circumstances. We also expect that such an approach will give issuers and market participants the flexibility to adopt different approaches to verification depending on the circumstances, to adapt to changing market practices, and to implement innovative approaches to meeting the verification requirement, such as the development of reliable third-party databases of accredited investors and verification services. In addition, we anticipate that many practices currently used by issuers in connection with existing Rule 506 offerings will satisfy the verification requirement for offerings pursuant to Rule 506(c). b. Non-Exclusive Methods of Verifying Accredited Investor Status In addition to adopting a principles-based method of verification, we are including in Rule 506(c) four specific non-exclusive methods of verifying accredited investor status for natural persons that, if used, are deemed to satisfy the verification requirement in Rule 506(c); provided, however, 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. 116 While the principles-based method of verification is intended to provide an issuer with the flexibility to address the particular facts and circumstances surrounding its offering, we appreciate the view of some commenters that the final rule should include a non-exclusive list of specific verification methods for natural persons that may be relied upon by those issuers seeking greater certainty that they satisfy the rule's verification requirement. 117 Accordingly, we are adding a non-exclusive list of specific verification methods to supplement our principles-based framework for verifying accredited investor status. 118 Issuers are not required to use any of the methods discussed below, and can apply the reasonableness standard directly to the specific facts and circumstances presented by the offering and the investors. 119 116 Because an issuer must have a reasonable belief that the purchaser is an accredited investor, the issuer could not form such reasonable belief if it has knowledge that the purchaser is not an accredited investor. See Section II.C of this release for a discussion of the reasonable belief standard in the definition of accredited investor in Rule 501(a). 117 See, e.g., letters from ACA (Sept. 27, 2012 and Dec. 11, 2012); Investor Advisory Committee; MFA (Sept. 28, 2012). 118 Information and documentation collected for these verification purposes may be subject to federal and/or state privacy and data security requirements. See, e.g., Regulation S-P [17 CFR 248.1-248.30] (implementing notice requirements and restrictions on a financial institution's ability to disclose nonpublic personal information about customers); Privacy of Consumer Financial Information (Regulation S-P), Release No. 34-42974 (June 22, 2000) [65 FR 40334 (June 29, 2000)]. 119 We expect that many issuers will conduct Rule 506(c) offerings in reliance on the principles-based method of verification, in light of its flexibility and efficiency. First, in verifying whether a natural person is an accredited investor on the basis of income, an issuer is deemed to satisfy the verification requirement in Rule 506(c) by reviewing copies of any Internal Revenue Service (“IRS”) form that reports income, including, but not limited to, a Form W-2 (“Wage and Tax Statement”), Form 1099 (report of various types of income), Schedule K-1 of Form 1065 (“Partner's Share of Income, Deductions, Credits, etc.”), and a copy of a filed Form 1040 (“U.S. Individual Income Tax Return”), 120 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. In the case of a person who qualifies as an accredited investor based on joint income with that person's spouse, an issuer would be deemed to satisfy the verification requirement in Rule 506(c) by reviewing copies of these forms for the two most recent years in regard to, and obtaining written representations from, both the person and the spouse. 120 A person could provide a redacted version of an Internal Revenue Service form so as to disclose only information about annual income and to avoid disclosure of personally identifiable information, such as a Social Security number, or other information that would not be relevant to the determination of a person's annual income. Second, 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 in Rule 506(c) by reviewing one or more of the following types of documentation, dated within the prior three months, 121 and by obtaining a written representation from such person that all liabilities necessary to make a determination of net worth have been disclosed. In the case of a person who qualifies as an accredited investor based on joint net worth with that person's spouse, an issuer would be deemed to satisfy the verification requirement in Rule 506(c) by reviewing such documentation in regard to, and obtaining representations from, both the person and the spouse. 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; and for liabilities: A consumer report (also known as a credit report) from at least one of the nationwide consumer reporting agencies is required. 122 Commenters did not provide examples of any other type of documentation that would, in our view, adequately evidence liabilities. 123 We recognize that it will be difficult for an issuer to determine whether it has a complete picture of a natural person's liabilities, and therefore, for purposes of this method, consistent with the suggestions of some commenters, we are requiring a consumer report and a written representation from such person that all liabilities necessary to make a determination of net worth have been disclosed. 121 A person could provide redacted versions of these documents so as to disclose only information about the amounts of assets and liabilities and to avoid disclosure of personally identifiable information, such as a Social Security number, or other information that would not be relevant to the determination of a person's net worth. 122 We note that the Fair Credit Reporting Act (“FCRA”) [15 U.S.C. 1681 et seq. ] requires each of the nationwide consumer reporting agencies to provide a person with a free copy of his or her consumer report, upon request, once every 12 months. In addition, the FCRA permits third parties to access individual consumer reports with the written permission of the individual. 123 One commenter suggested that the Commission “require the issuer to obtain a list of liabilities from the investor, which would include a sworn statement that all material liabilities are disclosed.” Letter from NASAA. Another commenter noted that liabilities can be cross checked against UCC 1 filings, bankruptcy information on Public Access to Court Electronic Records (PACER), and credit reports. See letter from P. Sigelman (Sept. 28, 2012). Third, an issuer is deemed to satisfy the verification requirement in Rule 506(c) by obtaining a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months and has determined that such purchaser is an accredited investor. 124 While third-party confirmation by one of these parties will be deemed to satisfy the verification requirement in Rule 506(c), depending on the circumstances, an issuer may be entitled to rely on the verification of accredited investor status by a person or entity other than one of these parties, provided that any such third party takes reasonable steps to verify that purchasers are accredited investors and has determined that such purchasers are accredited investors, and the issuer has a reasonable basis to rely on such verification. 124 For purposes of this method, a licensed attorney must be in good standing under the laws of the jurisdictions in which the attorney is admitted to practice law, and a certified public accountant must be in good standing under the laws of the place of the accountant's residence or principal office. Fourth, with respect to any natural person who invested in an issuer's Rule 506(b) offering as an accredited investor prior to the effective date of Rule 506(c) and remains an investor of the issuer, for any Rule 506(c) offering conducted by the same issuer, the issuer is deemed to satisfy the verification requirement in Rule 506(c) with respect to any such person by obtaining a certification by such person at the time of sale that he or she qualifies as an accredited investor. We are including the first three methods in our non-exclusive list of methods that are deemed to satisfy the verification requirement in Rule 506(c) because we believe that there will likely be few instances in which they would not constitute reasonable steps to verify accredited investor status. With respect to the verification method for the income test, there are numerous penalties for falsely reporting information in an Internal Revenue Service form, and these forms are filed with the Internal Revenue Service for purposes independent of investing in a Rule 506(c) offering. Similarly, we believe that the various forms of documentation set forth in the verification method for the net worth test ordinarily are generated for reasons other than to invest in a Rule 506(c) offering (with the possible exception of appraisal reports) and, in combination with a consumer report and a written representation from the investor regarding his or her liabilities, constitute sufficiently reliable evidence that such person's net worth exceeds $1 million, excluding the value of the person's primary residence. With respect to the third-party verification method, we have included written confirmations from certain third parties in our non-exclusive list of verification methods because these third parties are subject to various regulatory and/or licensing requirements. Registered broker-dealers 125 and SEC-registered investment advisers 126 are regulated by the Commission; and in the United States, attorneys and certified public accountants are licensed at the state level and are subject to rules of professional conduct 127 as well as, to the extent they appear or practice before the Commission in any way, to the Commission's Rules of Practice. 128 125 Registered broker-dealers are subject to a comprehensive system of oversight by the Commission as well as FINRA. In particular, registered broker-dealers, among other things, must maintain and preserve specified books and records, develop effective supervisory policies and controls, and comply with FINRA rules regarding registration and qualification requirements for their associated persons as well as general and specific conduct rules. In addition, registered broker-dealers are subject to examinations by both FINRA and Commission staff. 126 An investment adviser must register with the Commission unless it is prohibited from registering under Section 203A of the Investment Advisers Act of 1940 [15 U.S.C. 80b-3a] (the “Advisers Act”) or is exempt from registration under Advisers Act Section 203 [15 U.S.C. 80b-3]. Investment advisers that are prohibited from registering with the Commission instead may be subject to regulation by the states, but the antifraud provisions of the Advisers Act continue to apply to them. See Advisers Act Sections 203A(b) and 206 [15 U.S.C. 80b-3(a), 15 U.S.C. 80b-6]. SEC-registered investment advisers are subject to examinations by Commission staff. 127 Attorneys are subject to state standards for professional competence and ethical conduct, such as those based on the American Bar Association (“ABA”) Model Rules of Professional Conduct, which have been adopted by most states in the United States. For example, Rule 4.1 of the ABA Model Rules of Professional Conduct prohibits an attorney from knowingly making a false statement of material fact or law to a third person or failing to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client. Accountants are also subject to state standards for professional competence and ethical conduct, such as those based on the AICPA Code of Professional Conduct. See AICPA Code of Professional Conduct ET 201.01, 202.01; see also, e.g., The Uniform Accountancy Act (5th ed. 2007), available at: http://www.aicpa.org/Advocacy/State/StateContactInfo/uaa/DownloadableDocuments/UAA_Fifth_Edition_January_2008.pdf. The Commission recognizes that there may be particular considerations a certified public accountant would need to take into account to comply with applicable professional standards for attestation engagements to provide a report that constitutes a confirmation in the context of this rule. 128 See Rule 102(e) of the Rules of Practice [17 CFR 201.102(e)] (The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing and practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter: (i) Not to possess the requisite qualifications to represent others; or (ii) To be lacking in character or integrity or to have engaged in unethical or improper professional conduct; or (iii) To have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder.). We are including the fourth method in our non-exclusive list of methods that are deemed to satisfy the verification requirement in Rule 506(c) because we acknowledge that existing accredited investors who purchased securities in an issuer's Rule 506(b) offering prior to the effective date of Rule 506(c) would presumably participate in any subsequent offering by the same issuer conducted pursuant to Rule 506(c) based on their pre-existing relationships with the issuer. Accordingly, for these existing investors who were accredited investors in a Rule 506(b) offering prior to the effective date of Rule 506(c), a self-certification at the time of sale that he or she is an accredited investor will be deemed to satisfy the verification requirement in Rule 506(c). This provision does not extend to existing investors in an issuer who were not accredited investors in a Rule 506(b) offering that was conducted prior to the effective date of Rule 506(c). While we have not adopted the recommendations of commenters who believe that even more prescriptive verification requirements are needed, we do recognize the general concern regarding possible misuse of the new Rule 506(c) exemption to sell securities to those who are not qualified to participate in the offering. We will closely monitor and study the development of verification practices by issuers, securities intermediaries and others by undertaking a review of whether such practices are, in fact, resulting in the exclusion of non-accredited investors from participation in these offerings, and the impact of compliance with this verification requirement on investor protection and capital formation. C. Reasonable Belief That All Purchasers Are Accredited Investors In the Proposing Release, we noted that a number of commenters had raised concerns that the language of Section 201(a) of the JOBS Act could be interpreted as precluding the use of the “reasonable belief” standard in the definition of “accredited investor” in Rule 501(a) in determining whether a purchaser is an accredited investor, such that an issuer's determination as to whether a purchaser is an accredited investor is subject to an absolute, rather than a “reasonable belief,” standard. 129 In their view, issuers may be more reluctant to use general solicitation in Rule 506 offerings if their determinations as to whether a purchaser is an accredited investor are subject to an absolute standard. Other commenters had interpreted the difference in the statutory language used in Section 201(a)(1) and Section 201(a)(2) 130 as indicating Congress' intent that the Commission “raise the `reasonable belief' standard for Rule 506 offerings . . . .” 131 129 See, e.g., letters from ABA Fed. Reg. Comm. (Apr. 30, 2012); BlackRock (May 3, 2012); NYCBA (May 4, 2012); W. Sjostrom, Jr. (Apr. 14, 2012). 130 Section 201(a)(2) of the JOBS Act, which calls for amendments to Rule 144A, specifically refers to a “reasonable belief” standard as to whether a purchaser is a QIB, whereas Section 201(a)(1) does not mention a similar “reasonable belief” standard with respect to the amendments to Rule 506. 131 Letter from Fund Democracy (May 24, 2012). See also letter from Massachusetts Securities Division (July 2, 2012). Commenters on the Proposing Release were divided on the Commission's interpretation that the reasonable belief standard in Rule 501(a) applies to offerings under Rule 506(c). Several commenters supported this interpretation; 132 and other commenters opposed this interpretation. 133 132 See letters from ABA Fed. Reg. Comm. (stating that it “strongly support[s] the continued inclusion of the reasonable belief standard in the accredited investor definition, whether the offering is conducted under Rule 506(b) without general solicitation, or under Rule 506(c) with general solicitation”); IAA; MFA (Sept. 28, 2012) (stating that “[e]liminating the `reasonable belief' standard in the definition of accredited investor would preclude issuers from relying on Rule 506(c)” and that, if this were the case, “[i]ssuers would not engage in general solicitation and Section 201 would fail in its intended purposes to modernize the securities laws”); NSBA; NYCBA; P. Rutledge. 133 See letters from AFL-CIO and AFR (stating that “the legislative record reflects unmistakable congressional intent that securities sold through general solicitation and advertising under Rule 506 be sold only to accredited investors, not individuals issuers reasonably believe to be accredited investors”); Sen. Levin (stating that the “Proposed Rule also creates, with no statutory basis, an alternative to the `reasonable steps' requirement in the statute by stating that issuers may engage in a general solicitation or advertising so long as they `reasonably believe' that the investors to be addressed will be accredited”); Consumer Federation (stating that a reasonable belief standard “is in direct conflict with the statutory mandate that all investors in offerings sold through general solicitation and advertising be accredited investors and that the Commission specify methods issuers must follow to ensure that this is the case”); Fund Democracy (arguing that “Congress intentionally chose not to make such [a reasonable belief] exception to the mandate that Rule 506 purchasers be accredited investors”). We are reaffirming the view that we expressed on this issue in the Proposing Release. In our view, the difference in the language between Section 201(a)(1) and Section 201(a)(2) reflects only the differing manner in which the reasonable belief standard was included in the respective rules at the time they were adopted, and does not represent a Congressional intent to eliminate the existing reasonable belief standard in Rule 501(a) or for Rule 506 offerings. 134 We note that the definition of accredited investor remains unchanged with the enactment of the JOBS Act and includes persons that come within any of the listed categories of accredited investors, as well as persons that the issuer reasonably believes come within any such category. 134 Both Rule 506 and Rule 144A currently provide for a reasonable belief standard regarding the eligibility of an investor to participate in an offering under the respective rules, but they reach that result in different ways. For Rule 506, the Commission chose to include the reasonable belief standard within the Rule 501(a) definition of “accredited investor”; for Rule 144A, the Commission chose to include the standard as a condition, in paragraph (d)(1), to the use of the exemption. Further, as discussed in the Proposing Release, we continue to recognize that a person could provide false information or documentation to an issuer in order to purchase securities in an offering made under new Rule 506(c). Thus, even if an issuer has taken reasonable steps to verify that a purchaser is an accredited investor, it is possible that a person nevertheless could circumvent those measures. 135 If a person who does not meet the criteria for any category of accredited investor purchases securities in a Rule 506(c) offering, we believe that the issuer will not lose the ability to rely on Rule 506(c) for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor at the time of sale. 136 135 We note that several federal courts have been unsympathetic to attempts by investors who represented that they were accredited investors at the time of the sale of securities to subsequently disavow those representations in order to pursue a cause of action under the federal securities laws. See, e.g., Wright v. Nat'l Warranty Co., 953 F.2d 256 (6th Cir. 1991) (rejecting the plaintiffs' argument that Rule 505 was unavailable because the plaintiffs “specifically warranted and represented in the subscription agreement . . . that they were accredited investors”); Goodwin Properties, LLC v. Acadia Group, Inc., No. 01-49-P-C, 2001 U.S. Dist. LEXIS 9975 (D. Me. 2001) (noting that the plaintiffs “provided the defendants with reason to believe that they were accredited investors as defined by 17 C.F.R. § 230.501(a)” and stating that therefore “[t]hey cannot now disavow those representations in order to support their claims against the defendants”); Faye L. Roth Revocable Trust v. UBS Painewebber Inc., 323 F. Supp. 2d 1279 (S.D. Fla. 2004) (stating that the plaintiffs “cannot disavow their representations that they were accredited investors” and concluding that there was no material dispute that the offering complied with Regulation D). 136 Our views regarding an issuer's ability to maintain the exemption for a Rule 506(c) offering notwithstanding the fact that not all purchasers meet the criteria for any category of accredited investor are consistent with our views regarding the effect of attempts by prospective investors to circumvent the requirement in Regulation S that offers and sales be made only to non-U.S. persons. See Statement of the Commission Regarding Use of Internet Web sites to Offer Securities, Solicit Securities Transactions or Advertise Investment Services Offshore, Release No. 33-7516 (Mar. 23, 1998) [63 FR 14806 (Mar. 27, 1998)] (“In our view, if a U.S. person purchases securities or investment services notwithstanding adequate procedures reasonably designed to prevent the purchase, we would not view the Internet offer after the fact as having been targeted at the United States, absent indications that would put the issuer on notice that the purchaser was a U.S. person.”). D. Form D Check Box for Rule 506(c) Offerings Form D is the notice of an offering of securities conducted without registration under the Securities Act in reliance on Regulation D. 137 Under Rule 503 of Regulation D, an issuer offering or selling securities in reliance on Rule 504, 505 or 506 must file a notice of sales on Form D with the Commission for each new offering of securities no later than 15 calendar days after the first sale of securities in the offering. Form D is currently organized around 16 numbered “items” or categories of information. The information required to be provided in a Form D filing includes basic identifying information, such as the name of the issuer of the securities and the issuer's year and place of incorporation or organization; information about related persons (executive officers, directors, and promoters); the exemption or exemptions being claimed for the offering; and factual information about the offering, such as the duration of the offering, the type of securities offered and the total offering amount. 137 Form D also applies to offerings conducted using the Section 4(a)(5) exemption. The Commission adopted Form D when it adopted Regulation D in 1982. Release No. 33-6389 (adopting Form D as a replacement for Forms 4(6), 146, 240 and 242). 1. Proposed Form Amendment We proposed revising Form D to add a separate field or check box for issuers to indicate whether they are claiming an exemption under Rule 506(c). Item 6 of Form D currently requires the issuer to identify the claimed exemption or exemptions for the offering from among Rule 504's paragraphs and subparagraphs, Rule 505, Rule 506 and former Section 4(5), as applicable. Under the proposal, a new check box in Item 6 of Form D would require issuers to indicate specifically whether they are relying on the Rule 506(c) exemption. In addition, the current check box for “Rule 506” would be renamed “Rule 506(b),” and the current check box for “Section 4(5)” would be renamed “Section 4(a)(5)” to update the reference to former Section 4(5) of the Securities Act. We explained in the Proposing Release that this revision would provide additional information needed to assist our efforts to analyze the use of general solicitation in Rule 506(c) offerings and the size of this offering market. The information would also help us to look into the practices that may develop to satisfy the verification requirement, which would assist us in assessing the effectiveness of various verification practices in identifying and excluding non-accredited investors from participation in Rule 506(c) offerings. 2. Comments on the Proposed Form Amendment Most commenters who expressed a view on the proposed checkbox in Form D supported the addition of this checkbox for issuers to indicate whether they are relying on Rule 506(c) for their offerings. 138 Only one commenter opposed the proposed checkbox. 139 A number of commenters recommended that the Commission include additional information requirements in Form D for Rule 506(c) offerings, beyond a checkbox to indicate reliance on Rule 506(c). 140 Some commenters asked for confirmation that issuers may check both the Rule 506(b) box and the Rule 506(c) box in a Form D under certain circumstances. 141 138 See, e.g., letters from MFA (Sept. 28, 2012); BIO; S&C; Tannenbaum Helpern; ABA Fed. Reg. Comm.; IAA; SIFMA and FSR (Oct. 5, 2012); SRC of NYSBA. 139 Letter from J. McLaughlin (stating that “Section 201(a)(1) does not authorize the Commission to impose a separate Form D filing requirement on issuers who choose to engage in general solicitation”). 140 See, e.g., letters from AARP; AFL-CIO and AFR; Consumer Federation; Investor Advisory Committee; NASAA; Massachusetts Securities Division (July 2, 2012); Fund Democracy. 141 See letters from J. Gross; NYCBA; IAA. 3. Final Form Amendment We are adopting the revision to Form D as proposed. Issuers conducting Rule 506(c) offerings must indicate that they are relying on the Rule 506(c) exemption by marking the new check box in Item 6 of Form D. Further, as proposed, the current check box for “Rule 506” will be renamed “Rule 506(b),” and the current check box for “Section 4(5)” will be renamed “Section 4(a)(5).” We are of the view that an issuer will not be permitted to check both boxes at the same time for the same offering. We remind issuers that once a general solicitation has been made to the purchasers in the offering, 142 an issuer is precluded from making a claim of reliance on Rule 506(b), which remains subject to the prohibition against general solicitation, for that same offering. 142 That is, the purchasers became interested in the offering because of, or through, the general solicitation, and not through some means other than the general solicitation, such as through a substantive, pre-existing relationship with the company or direct contact by the company or its agents outside of the general solicitation. See Revisions of Limited Offering Exemptions in Regulation D, Release No. 33-8828 (Aug. 3, 2007) [72 FR 45116, 45129 (Aug. 10, 2007)]. E. Specific Issues for Private Funds Private funds, such as hedge funds, venture capital funds and private equity funds, typically rely on Section 4(a)(2) and Rule 506 to offer and sell their interests without registration under the Securities Act. 143 In addition, private funds generally rely on one of two exclusions from the definition of “investment company” under the Investment Company Act—Section 3(c)(1) 144 and Section 3(c)(7) 145 —which enables them to be excluded from substantially all of the regulatory provisions of that Act. 146 Private funds are precluded from relying on either of these two exclusions if they make a public offering of their securities. 147 Section 3(c)(1) excludes from the definition of “investment company” any issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than 100 beneficial owners, 148 and which is not making and does not presently propose to make a public offering of its securities. Section 3(c)(7) excludes from the definition of “investment company” any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers,” 149 and which is not making and does not at that time propose to make a public offering of its securities. 143 See, e.g., Implications of the Growth of Hedge Funds, Staff Report to the Securities and Exchange Commission (Sept. 2003) (“Staff Report on Hedge Funds”), available at: http://www.sec.gov/news/studies/hedgefunds0903.pdf. 144 15 U.S.C. 80a-3(c)(1). 145 15 U.S.C. 80a-3(c)(7). 146 We also refer in this release to “pooled investment funds” because that term is used in Form D. Issuers that rely on Section 3(c)(1) or 3(c)(7) of the Investment Company Act are a subset of pooled investment funds. 147 See also Section 202(a)(29) of the Advisers Act [15 U.S.C. 80b-2(a)(29)] (defining a “private fund” as an issuer that would be an investment company under the Investment Company Act, but for Sections 3(c)(1) or 3(c)(7) of that Act). Many ABS issuers also rely on the exclusions contained in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. These ABS issuers frequently participate in Rule 144A offerings. 148 See also Rule 3c-5 under the Investment Company Act [17 CFR 270.3c-5] (providing that the section's limit of 100 beneficial owners does not include “knowledgeable employees,” as defined in the rule). 149 See Section 2(a)(51) of the Investment Company Act [15 U.S.C. 80a-2(a)(51)] and the rules there under. See Also Rule 3c-5 under the Investment Company Act (excluding “knowledgeable employees” from the determination of whether all of the outstanding securities of the fund relying on Section 3(c)(7) are owned exclusively by qualified purchasers). Section 201(a)(1) of the JOBS Act directs the Commission to eliminate the prohibition against general solicitation for a new category of Rule 506 offerings, and makes no specific reference to private funds. Section 201(b) of the JOBS Act also provides that “[o]ffers and sales exempt under [Rule 506, as revised pursuant to Section 201(a)] shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.” We historically have regarded Rule 506 transactions as non-public offerings for purposes of Sections 3(c)(1) and 3(c)(7). 150 As we stated in the Proposing Release and reaffirm here, the effect of Section 201(b) is to permit private funds to engage in general solicitation in compliance with new Rule 506(c) without losing either of the exclusions under the Investment Company Act. 150 See Release No. 33-6389 (noting that the “Commission regards rule 506 transactions as non-public offerings for purposes of the definition of `investment company' in section 3(c)(1) of the Investment Company Act”); Privately Offered Investment Companies, Release No. IC-22597 (Apr. 3, 1997) [62 FR 17512 (Apr. 9, 1997)], at n. 5 (noting that the “Commission believes that section 3(c)(7)'s public offering limitation should be interpreted in the same manner as the limitation in section 3(c)(1)”). A few commenters argued that Section 201(b) does not permit private funds to engage in general solicitation under proposed Rule 506(c) without losing their exclusions under the Investment Company Act. 151 In our view, although Section 201(b) does not explicitly reference the meaning of “public offering” under the Investment Company Act, it clearly states that “[o]ffers and sales exempt under [Rule 506, as revised pursuant to Section 201(a)] shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation” (emphasis added). As the Investment Company Act is a federal securities law, the effect of Section 201(b) is to permit offers and sales of securities under Rule 506(c) by private funds relying on the exclusions from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. 151 See letter from Fund Democracy (stating that “Section 201(b) refers only to Rule 506; it makes no reference to the meaning of `public offering' under the Investment Company Act exemptions”). See also letter from AFL-CIO and AFR. Some commenters expressed concerns about private funds engaging in general solicitation under proposed Rule 506(c). 152 Other commenters, however, supported the removal of the prohibition against general solicitation in Rule 506(c) offerings with respect to private funds, 153 with some commenters stating that the removal of the ban would bring greater transparency to the private fund industry and allow managers of private funds to communicate more effectively with the public and prospective investors. 154 152 See, e.g., letters from A. La Rosa; A. Pierwola; AFL-CIO and AFR; C. Erickson; Consumer Federation; E. Guthrie; F. Urling; Fund Democracy; J. Clark; K. Pesson; M. Gessford; M. Trail; M. Zartler; R. Dunn; S. Johnston; W. Cunningham. 153 See, e.g., letters from BlackRock; Dukas; Forum for U.S. Securities Lawyers in London; HFA; IAA; MFA (Sept. 28, 2012); NYCBA; SRC of NYSBA. 154 See, e.g., letters from Dukas; HFA. Some commenters who were concerned about private funds engaging in general solicitation recommended that we impose additional conditions on private funds that rely on Rule 506(c). In particular, a number of commenters believed that private funds engaging in general solicitation should be subject to some form of content and/or other restrictions, and suggested potential methods. 155 For example, some believed that, in order to engage in general solicitation, private funds should be held to performance and advertising standards that are analogous to mutual fund standards. 156 One of these commenters suggested that the Commission develop rules tailored to the ways private funds calculate and present investment performance, rather than extending mutual fund performance rules to private funds. 157 Some made other suggestions, such as requiring each private fund relying on Rule 506(c) to disclose that the private fund is not registered with the Commission and should not be confused with a registered fund, such as a mutual fund. 158 With respect to private funds sold through broker-dealers subject to FINRA's rules of conduct, some commenters believed that we should direct FINRA to require the filing and review of private fund advertisements. 159 155 See, e.g., letters from ICI; AFL-CIO and AFR; C. Corn; Sen. Levin (stating that “Congress did not contemplate removing the general solicitation ban—without retaining any limitations on forms of solicitation—for private investment vehicles”); Consumer Federation; D. Kronheim; D. Smith; Fund Democracy; G. Lavy; G. Morin; Investor Advisory Committee; IDC; J. Sanders; Rep. Waters; NASAA; P. Turney; Sens. Reed, Levin, Durbin, Harkin, Lautenberg, Franken and Akaka. 156 See, e.g., letters from C. Corn; Sen. Levin (noting that “[a]lready, the Commission has determined that the manner and substance of solicitation and advertising for investments in registered investment companies deserves significant regulatory oversight. Many of those same concerns apply to investments in private investment vehicles. Accordingly, the Commission should impose analogous protections for investments in private funds.”); Consumer Federation (stating that “[s]hort of an outright prohibition on general solicitation and advertising by private funds, the Commission should at the very least adopt clear standards for the reporting of performance and fees by private funds, and delay their eligibility from engaging in general solicitation and advertising until such time as those standards are in place,” including a requirement to include in private fund advertisements “a clear, prominent warning that they are not mutual funds and carry special risks.”); D. Kronheim; D. Smith; Fund Democracy (noting that an alternative would be to “apply mutual fund advertising and valuation rules to hedge funds that engage in [general solicitation and advertising] (and, in any case, require standardized performance and fee reporting for all hedge funds), and require explicit, large-font disclaimers that hedge funds are not mutual funds and present special risks.”); G. Lavy; ICI (recommending content restrictions on private fund advertising at least as extensive as those currently applicable to mutual funds ( e.g., disclaimers regarding the performance figures or measures displayed in any advertisement), with a prohibition on use of performance advertising until the Commission can develop a new rule regarding such advertising); IDC; NASAA (stating that “because the investment strategies of private funds are typically more opaque, risky, and illiquid than those of mutual funds, private fund advertisements should be subject to restrictions that are comparable to the rules for mutual funds.”); P. Turney. 157 See letter from ICI (arguing that the antifraud provisions in Section 206(4) of the Advisers Act [15 U.S.C. 80b-6(4)] and Rule 206(4)-8 thereunder [17 CFR 275.206(4)-8] would not be enough to protect investors because these advertisements will be presented before accredited and non-accredited investors at the same time). 158 See letters from ICI; IDC. 159 See letters from AFL-CIO and AFR (stating that “FINRA already pre-reviews broker-dealer advertising; the same requirement should apply to general solicitation and advertising in Rule 506 offerings in light of the significant potential for abuse.”); ICI (noting that “FINRA has developed an infrastructure to handle such filings and an expertise to substantively review them, and accordingly is best positioned to handle this task.”). Finally, some commenters opposed the imposition of content and/or other restrictions for private funds. 160 They asserted that purchasers of the securities of a private fund that relies on Rule 506(c), must be, at a minimum, accredited investors and thus have met objective criteria demonstrating financial sophistication, which they believed eliminates the risk that other types of investors could be defrauded. 161 A number of commenters pointed out that advertisements of private funds are subject to the antifraud provisions of the federal securities laws and suggested that liability under such provisions provides sufficient investor protections. 162 160 See, e.g., letters from Verrill Dana LLP (stating that “[t]here is no suggestion in Section 201 that the Commission must distinguish between `issuers that engage in operational businesses' and `those that are merely investment vehicles'”); Artivest (noting that for private funds managed by a registered commodity pool operator, the National Futures Association Rule 2-29 contains standards regarding marketing materials). 161 In general, private funds that pay performance fees to their managers are available only to “qualified clients” that have at least $1 million in assets under management or that have a net worth of $2 million (excluding the value of the client's primary residence). See Rule 205-3 under the Advisers Act [17 CFR 275.205-3]. See also letter from BlackRock. 162 See, e.g., letters from BlackRock; HFA; MFA (Mar. 22, 2013). We have carefully considered commenters' suggestions and concerns. We are mindful of certain commenters' concerns that private funds engaging in general solicitation may raise certain investor protection issues. We also understand that other commenters believe that additional measures regarding private fund advertising are not necessary because the antifraud provisions of the federal securities laws continue to apply. We will monitor and study the development of private fund advertising and undertake a review to determine whether any further action is necessary. We remind investment advisers to private funds that they are subject to Rule 206(4)-8 under the Advisers Act. 163 Rule 206(4)-8 provides that it shall constitute a fraudulent, deceptive or manipulative act, practice or course of business within the meaning of Section 206(4) of the Advisers Act for any investment adviser to a pooled investment vehicle 164 to “(1) [m]ake any untrue statement of a material fact or to omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle; or (2) otherwise engage in any act, practice or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle.” 165 163 17 CFR 275.206(4)-8. 164 Rule 206(4)-8 defines a pooled investment vehicle to mean any investment company as defined in Section 3(a) of the Investment Company Act [15 U.S.C. 80a-3(a)] or any company that would be an investment company under Section 3(a) of that Act but for the exclusion provided from that definition by either Section 3(c)(1) or Section 3(c)(7) of that Act [15 U.S.C. 80a-3(c)(1) or (7)]. 165 Id. As was stated by the Commission when it adopted Rule 206-4(8), “[t]he rule clarifies that an adviser's duty to refrain from fraudulent conduct under the federal securities laws extends to the relationship with ultimate investors and that the Commission may bring enforcement actions under the Advisers Act against investment advisers who defraud investors or prospective investors in those pooled investment vehicles.” 166 We further stated that we “intend to employ all of the broad authority that Congress provided us in section 206(4) and direct it at adviser conduct affecting an investor or potential investor in a pooled investment vehicle.” 167 Recently, for example, we have brought enforcement actions against private fund advisers and others for material misrepresentations to investors and prospective investors regarding fund performance, strategy, and investments, among other things. 168 166 Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Release No. IA-2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)]. 167 Id. 168 See, e.g., In the Matter of Oppenheimer Asset Management Inc. and Oppenheimer Alternative Investment Management, LLC, Release No. IA-3566 (Mar. 11, 2013); In the Matter of Sentinel Investment Management Corp., Release No. IA-3530 (Dec. 27, 2012); In the Matter of Weizhan Tang, Release No. IA-3482 (Oct. 5, 2012); In the Matter of Calhoun Asset Management, LLC, et al., Release No. IA-3428 (July 9, 2012); In the Matter of Belal K. Faruki, Release No. IA-3405 (May 17, 2012); In the Matter of GMB Capital Management LLC, et al., Release No. IA-3399 (Apr. 20, 2012). We believe that investment advisers that have implemented appropriate policies and procedures regarding, among other things, the nature and content of private fund sales literature, including general solicitation materials, are less likely to use materials that materially mislead investors or otherwise violate the federal securities laws. Accordingly, we believe that investment advisers to private funds should carefully review any such policies and procedures that have been implemented to determine whether they are reasonably designed to prevent the use of fraudulent or materially misleading private fund advertising and make appropriate amendments to those policies and procedures, particularly if the private funds intend to engage in general solicitation activity. 169 169 We remind investment advisers that are registered or required to be registered under Section 203 of the Advisers Act that they must adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act which include, but are not limited to, violations of Section 206 o [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2013-16883. Public record. Not legal advice.