Articles Tagged with Regulation D

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In a press release yesterday, the CFTC issued an exemptive letter, CFTC Letter No. 14-116, providing relief from certain provisions of CFTC Regulations 4.7(b) and 4.13(a)(3) that restrict marketing to the public.  The exemptive relief was issued to make CFTC Regulations 4.7(b) and 4.13(a)(3) consistent with SEC Rule 506(c) of Reg. D and Rule 144A, which were amended by the Jumpstart Our Business Startups Act (JOBS Act), to permit general solicitation or advertising subject to certain limitations.

Generally, the JOBS Act adopted SEC Rule 506(c) to permit an issuer, subject to the conditions of the rule, to engage in general solicitation or general advertising when offering and selling securities, and amended SEC Rule 144A to permit the use of general solicitation, subject to the limitations of the rule, when securities are sold to qualified institutional buyers (“QIBs”) or to purchasers that the seller reasonably believes are QIBs.  Prior to the CFTC’s exemptive relief, commodity pool operators (“CPOs”) relying on CFTC Regulations 4.7(b) and 4.13(a)(3) were not able to use general solicitation under Rule 506(c) or Rule 144A, as the CFTC exemptions prohibited general solicitation.

The new relief from provisions in CFTC Regulations 4.7(b) and 4.13(a)(3) is subject to the following conditions:

  1. The exemptive relief is strictly limited to CPOs who are 506(c) Issuers or CPOs using 144A Resellers.
  2. CPOs claiming the exemptive relief must file a notice with the Division.  The notice of claim of exemptive relief must:
  • State the name, business address, and main business telephone number of the CPO claiming the relief;
  • State the name of the pool(s) for which the claim is being filed;
  • State whether the CPO claiming relief is a 506(c) Issuer or is using one or more 144A Resellers;
  • Specify whether the CPO intends to rely on the exemptive relief pursuant to Regulation 4.7(b) or 4.13(a)(3), with respect to the listed pool(s);

 i.      If relying on Regulation 4.7(b), represent that the CPO meets the conditions
of the exemption, other than that provision’s requirements that the offering be
exempt pursuant to section 4(a)(2) of the 33 Act and be offered solely to QEPs,
such that the CPO meets the remaining conditions and is still required to sell
the participations of its pool(s) to QEPs;
ii.       If relying on Regulation 4.13(a)(3), represent that the CPO meets the
conditions of the exemption, other than that provision’s prohibition against
marketing to the public;

  • Be signed by the CPO; and
  • Be filed with the Division via email using the email address dsionoaction@cftc.gov and stating “JOBS Act Marketing Relief” in the subject line of such email.
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Written by: Jay B. Gould

On October 23, 2013, the Securities and Exchange Commission (“SEC”) voted unanimously to propose rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding.

Crowdfunding describes an evolving method of raising capital that has been used outside of the securities arena to raise funds through the Internet for a variety of projects, products or artistic endeavors. Crowdfunding has generally not been used as a means to offer and sell securities because offering a share of the financial returns or profits from business activities would likely trigger the registration provisions of the federal securities laws relating to the offer or sale of securities.

Title III of the JOBS Act created an exemption under the securities laws so that this type of funding method can also be used to offer and sell securities without registration. The JOBS Act established the framework for a regulatory structure for this funding method. It also created a new entity – a funding portal – to allow Internet-based platforms or intermediaries to facilitate the offer and sale of securities without having to register with the SEC as brokers. Crowdfunding should not be confused with rules that were recently adopted under Regulation D that permits issuers of securities of private companies to engage in general solicitation or public advertising related to the sales of such securities.

The intent of the JOBS Act was to make it easier for startups and small businesses to raise capital from a wide range of potential investors and provide additional investment opportunities for investors. Critics, led by consumer groups and state securities administrators, have been critical of both the Regulation D amendments regarding general solicitation, as well as the crowdfunding provisions, as opening the floodgates for fraudster to prey on the financially unsophisticated. Accordingly, the challenge for the SEC is to establish a regulatory structure that both permits small companies and entrepreneurs to access investors in an efficient manner, while protecting the investors from scam artists.

Proposed Rules
The proposed rules would among other things permit individuals to invest subject to certain thresholds, limit the amount of money a company can raise, require companies to disclose certain information about their offers, and create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions.

Under the proposed rules:

  • A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period.
  • Investors, over the course of a 12-month period, would be permitted to invest up to:

$2,000 or 5 percent of their annual income or net worth, whichever is greater, if both their annual income and net worth are less than $100,000.

10 percent of their annual income or net worth, whichever is greater, if either their annual income or net worth is equal to or more than $100,000. During the 12-month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies (such as hedge funds), companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies.

Securities purchased in a crowdfunding transaction cannot be resold for a 12-month period. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Securities Exchange Act of 1934.

Disclosure by Companies
The proposed rules would require companies conducting a crowdfunding offering to file certain information with the SEC, provide it to investors and the relevant intermediary facilitating the crowdfunding offering, and make it available to potential investors.

In its offering documents, among the things the company would be required to disclose are:

  • Information about officers and directors as well as owners of 20 percent or more of the company.
  • A description of the company’s business and the use of proceeds from the offering.
  • The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
  • Certain related-party transactions.
  • A description of the financial condition of the company.
  • Financial statements of the company that, depending on the amount offered and sold during a 12-month period, would have to be accompanied by a copy of the company’s tax returns or reviewed or audited by an independent public accountant or auditor.

Companies would be required to amend the offering document to reflect material changes and provide updates on the company’s progress toward reaching the target offering amount.

Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.

Crowdfunding Platforms
Title III of the JOBS Act requires that crowdfunding transactions take place through an SEC-registered intermediary, either a broker-dealer or a funding portal. Under the proposed rules, the offerings would be conducted exclusively online through a platform operated by a registered broker or a funding portal, which is a new type of SEC registrant.

The proposed rules would require these intermediaries to:

  • Provide investors with educational materials.
  • Take measures to reduce the risk of fraud.
  • Make available information about the issuer and the offering.
  • Provide communication channels to permit discussions about offerings on the platform.
  • Facilitate the offer and sale of crowdfunded securities.

The proposed rules would prohibit funding portals from:

  • Offering investment advice or making recommendations.
  • Soliciting purchases, sales or offers to buy securities offered or displayed on its website.
  • Imposing certain restrictions on compensating people for solicitations.
  • Holding, possessing, or handling investor funds or securities.

The proposed rules would provide a safe harbor under which funding portals can engage in certain activities consistent with these restrictions.

What’s Next?
The SEC will take public comments on the proposed rules for 90 days, after which it will review the comments and determine whether to adopt the proposed rules. Depending upon the tone and substance of the comments, the SEC may move quickly to adopt the rules as proposed, adopt the rules with certain modifications based on the comments, or re-propose the rule for additional public comment. Anxious market participants should not expect to start offering their crowdfunding securities.

Follow @Investment_Law on Twitter.

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Written by:  Jay B. Gould and Jessica Brown

On July 10, 2013, the Securities and Exchange Commission (“SEC”) voted to lift the ban on general solicitation and advertising by private funds (and other private company issuers) as mandated by Congress in the Jumpstart Our Business Startups Act (“JOBS Act”). In addition to lifting the ban on general solicitation, the SEC approved a disqualification rule that will prospectively prohibit any felon or “bad actor” from relying on Rule 506 exemptions. Finally, the SEC voted to propose amendments to the current private offering rules.

I.          New Rule 506(c) 

Summary

Rule 506(c), as adopted by the SEC, permits private issuers to use general solicitation and general advertising when making a securities offering, provided the issuer only sells to accredited investors.[1] Issuers must take affirmative and reasonable steps to verify that each investor is accredited under the Rule 501 definition, and cannot simply rely upon a representation from the investor.

Verification Rule

The burden now shifts to private fund managers to determine “reasonableness” when making a determination of an investor’s accredited status. In response to comments it received, the SEC has provided some ideas an issuer can consider when determining its verification procedures. The non-exclusive, non-required verification methods published by the SEC include: (i) review federal tax forms, (ii) confirm net worth through documentation, or (iii) obtain written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney in good standing, or registered CPA.  Accordingly, private fund managers will be able to rely upon certain third parties to make a determination of accreditation.

Current Rule 506 Exemptions

Rule 506(c) does not modify or repeal any of the current Rule 506 exemptions and issuers may still rely on those exemptions as written.   Therefore, private fund managers that do not see the value in advertising or soliciting to the public, or find the conditions of the new rules too onerous, may continue under the current private offering regime and will remain subject to all of the same restrictions on communications with the public to which they are currently subject. 

Form D

The current Form D filing document will be amended to include a “check-the-box” option to designate if the issuer is relying on the new Rule 506(c) in its present offering.  For those private funds and other issuers that do intend to generally advertise, the SEC has proposed that a Form D would need to be filed with the SEC 15 days in advance of the offering and again within 30 days after the offering closes.  It is proposed that an issuer that fails to make these filings would be prohibited from using the public advertising rules in the future.

II.        Rule 144A

Similar to the changes to Rule 506, under the new rules, securities sold pursuant to Rule 144A may be “offered” to investors other than qualified institutional buyers, because information about such offerings would be made public by way of general advertising, but the securities may only be sold to investors the seller reasonably believes to be qualified institutional buyers.[2]

III.       Felons and “Bad Actors” Disqualification

The SEC unanimously adopted a rule that disqualifies certain felons and “bad actors” from relying on any Rule 506 exemption.[3] This disqualification will be effective sixty days after the publication of the final rules in the Federal Register. 

The SEC identified a number of events that would disqualify an issuer from relying on Rule 506, such as securities-related criminal convictions, court injunctions and restraining orders, final orders from regulators and agencies, certain SEC disciplinary orders, anti-fraud or registration-related cease-and-desist orders from the SEC, SEC stop orders, suspension or expulsion from membership or association with a self-regulated organization, or recent U.S. Postal Service false representation orders. 

However, much to the consternation of the lone dissenting Commissioner Luis Aguilar, this provision will not bar persons who have committed financial and other crimes in the past.  It will only bar such bad actors on a going forward basis. Presumably, the fact that a principal of an issuer is a convicted felon would be a material fact that would be required to appear in the offering materials of the issuer, and for private funds, this information would, in most cases, get picked up in the Form ADV of the fund manager.

IV.       What Happens Next

Timing

The effective date of Rule 506(c) and the disqualification rule is 60 days following the date the rule is published in the Federal Register. For an ongoing offering under Rule 506 that began before the effective date of Rule 506(c), the issuer may elect to continue the offering after the effective date in accordance with the requirements of either the current Regulation D rule or new Rule 506(c), which permits general solicitation and advertising.  Accordingly, if an issuer chooses to continue its offering under Rule 506(c), any general solicitations that take place after the effective date, will not impact the exempt status of offers and sales that took place prior to the effective date in reliance on Rule 506(b).

What Funds Can Do Now

After the effective date of Rule 506(c), private funds that are not otherwise disqualified from using the Rule 506 exemptions may begin advertising and soliciting generally. An issuer that chooses to advertise or solicit generally must put policies and procedures in place to ensure that reasonable steps are taken to verify that each purchaser is accredited and that no sales are made to non-accredited investors.

Limitations, CFTC Considerations and Fund Advertising

Since February 2012, when the Commodity Futures Trading Commission (“CFTC”) rescinded Rule 4.13(a)(4), most private funds have relied upon the de minimus exemption of Rule 4.13(a)(3) in order to be exempt from CFTC registration. Other funds that trade futures or other instruments that are subject to CFTC oversight above the de minimus threshold, avail themselves of the “registration lite” exemption in Rule 4.7, pursuant to which all fund investors must be “qualified eligible persons.”  However, both of these exemptions require that the fund securities must be offered and sold without any marketing to the public in the United States.  Therefore, until the CFTC acts to amend these exemptive rules on which many private fund managers rely, none of these private funds will be able to use the general solicitation provisions of new Rule 506(c).  The Managed Funds Association submitted an outline of proposed rule amendments to the CFTC that would harmonize the CFTC rules with the SEC’s JOBS Act rules, but it is uncertain when the CFTC will act on this matter.

For a discussion of these provisions, see this discussion on Bloomberg. 

Proposed Amendments to Regulation D, Form D and Rule 156

In connection with the approval of Rule 506(c), the SEC proposed amendments to Regulation D, Form D and Rule 156 under the Securities Act. These proposed “investor protection” amendments are intended to enhance the SEC’s ability to evaluate market changes, the nature of advertising used by issuers, the steps taken by the issuer to verify that all investors were accredited and the intended use of the proceeds of the sale. It is likely that these provisions will soon become part of the new Form D and be applicable to private fund managers that advertise or solicit to the public. 

Finally, fund managers and their compliance officers should familiarize themselves with the requirements of Rule 156, as it appears likely that this anti-fraud rule will soon apply to the sales literature and advertising produced by hedge fund and private equity funds.

Questions regarding new Rule 506(c), the CFTC rules, Rule 156 and other implications regarding this recent SEC action should be directed to your Pillsbury attorney contact.

 


[1] Rule 501 of Regulation D defines an individual as an “accredited investor” if they have individual net worth, or joint net worth with the person’s spouse, in excess of $1 million at the time of the purchase, excluding the value of the primary residence of such person, or with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

[2] Rule 144A defines “qualified institutional buyers” as certain institutions that own and invest at least $100 million in securities of issuers that are unaffiliated with the institutions, banks and financial institutions must also have a net worth in excess of $25 million. A registered broker-dealer qualifies if it owns and invests on a discretionary basis over $10 million in securities of issuers that are unaffiliated with the broker-dealer. 

[3] An issuer will be disqualified from relying on Rule 506 exemptions if any “covered person” has had a “disqualifying event.” The rule defines “covered persons” as: (i) the issuer, (ii) the issuer’s predecessors and affiliated issuers, (iii) directors and certain officers, general partners and managing members of the issuer, (iv) 20 percent beneficial owners of the issuer, (v) promoters, (vi) investment managers and principals of pooled investment funds, and (vii) persons compensated for soliciting investors as well as the general partners, directors, officers, and managing members of any compensated solicitor.

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Written by:  Jay Gould and Peter Chess

Heath Abshure, President of the North American Securities Administrators Association (NASAA) and Arkansas State Securities Commissioner, sharply criticized the Securities and Exchange Commission’s (the SEC’s) new rulemaking that will lift restrictions on general solicitation and general advertising for hedge funds and other private investment vehicles in a press-teleconference on October 9, 2012.  At the heart of the criticism is the contention that hedge funds and private equity funds could be among the amended rule’s biggest users and beneficiaries. “The SEC’s proposed rule would open the door for private equity and hedge funds, typically only offered to the most sophisticated investors, to advertise to the general public without putting in place basic disclosure requirements that would allow investors to make informed decisions about the products being offered. This is the wrong way to go,” remarked Heath Slavkin Corzo, senior legal and policy advisor of the AFL-CIO’s Office of Investment during the teleconference.

Under the Jumpstart Our Business Startups Act (the JOBS Act), as discussed here and here, the SEC was directed to amend Rule 506 of Regulation D under the Securities Act of 1933, as amended, to permit general solicitation and general advertising in unregistered offerings made under Rule 506, provided that all purchasers of the securities are accredited investors.  In reaction to the SEC’s answer to the directives of the JOBS Act, Abshure called for the SEC to withdraw its proposal and draft a new rule that promotes capital formation without sacrificing investor protection.

“People don’t seem to think so, but this is a drastic change to the face of securities regulation,” Abshure said. “Rule 506 offerings already are the most frequent financial product at the heart of state enforcement investigations and actions. Lifting the advertising ban on these highly risky, illiquid offerings, without requiring appropriate safeguards, will create chaos in the market and expose investors to an even greater risk of fraud and abuse. Without adequate investor protections to safeguard the integrity of the private placement marketplace, investors should and will flee from the market, leaving small businesses without an important source of capital.”

“The Commission itself has acknowledged that lifting the ban on general solicitation in private offerings will increase the risk of fraud, potentially harming investors and issuers alike,” added Barbara Roper, Director of Investor Protection for the Consumer Federation of America and the chair of the Investor Issues task force of Americans for Financial Reform during the teleconference. “While the Commission is required by the JOBS Act to lift the solicitation ban, it also has an obligation to adopt rules that protect investors and promote market integrity and the authority to do so.  A number of reasonable, concrete proposals have been suggested that, if adopted, would significantly improve safeguards for investors in private offerings.  Its rule proposal completely ignores those suggestions.  It cannot in good conscience continue to do so.”

The full press release about the teleconference is available here