Sullivan & Cromwell discusses SEC Amendments to Private Offerings Rules

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On July 10, 2013, the Securities and Exchange Commission took action on three proposals relating to private offerings:

  • Adopted final amendments to Rule 506 of Regulation D and Rule 144A under the Securities Act to eliminate the prohibition on general solicitation in offerings conducted under those rules, as mandated by Section 201(a) of the JOBS Act.
  • Adopted final amendments to Rule 506 to disqualify certain felons and other “bad actors” from participating in offerings under the Rule, as mandated by Section 926 of the Dodd-Frank Act.
  • Proposed additional amendments to Regulation D, Form D and Rule 156 under the Securities Act to address investor-protection concerns relating to the elimination of the prohibition on general solicitation under Rule 506.

With regard to general solicitation, the final changes are substantially similar to those originally proposed, with one modification. As directed by the JOBS Act, new paragraph (c) of Rule 506 permits issuers to use general solicitation in a Rule 506 offering, provided that the securities are sold only to accredited investors and the issuer takes reasonable steps to verify that all purchasers are accredited investors. While the SEC declined to mandate specific methods of verification, the final rule sets forth several non- exclusive, non-mandatory methods that may be used to verify the status of individual accredited investors.

The final “bad actor” disqualification provisions are similar to those originally proposed in May 2011, with some notable differences. The definition of “covered persons” subject to the provisions is narrower in some respects – e.g., with regard to officers and equity owners of the issuer – but broader in others – e.g., adding investment managers and their principals for issuers that are pooled investment funds. In addition, the list of disqualifying events has been expanded to include certain orders of the CFTC as well as SEC cease-and-desist orders arising out of scienter-based violations of the anti-fraud provisions of the federal securities laws and violations of Section 5 of the Securities Act. Most notably, as adopted, the disqualification provisions will be triggered only by events that occur after the effective date of the amendments, although pre-existing events that would otherwise have triggered disqualification will be subject to mandatory disclosure.

To address concerns that eliminating the ban on general solicitation in offerings under new Rule 506(c) may create risks for investors, the SEC proposed several changes to Regulation D, Form D and Rule 156 that would enable the SEC to gather information on how the new rule affects the private offering market and practices that develop under the new rule. If adopted as proposed, these changes would significantly alter the way in which hedge funds, private equity funds and other private offering participants conduct offerings. The proposed changes would expand the disclosure required in Form D filings, and would require those filings to be made at least 15 days before the commencement of any general solicitation and to be updated after sales begin and when the offering is completed. Although the Rule 506 exemption would continue not to be conditioned on Form D filing, failure to file would preclude future reliance on Rule 506 for one year in some cases. The proposed changes would also require written general solicitation materials to include certain legends and other disclosures and, for the next two years, to be submitted to the SEC confidentially. Finally, the proposals would extend the antifraud guidance contained in Rule 156 to apply to the sales literature of private funds in all private offerings whether or not in reliance on Rule 506.

The final rules will become effective 60 days after publication in the Federal Register. Comments on the proposed rules will be due 60 days after publication in the Federal Register.