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July 4th fireworks came a week late to 100 F Street yesterday, as the SEC adopted the changes to Rule 506 of Regulation D mandated by Title II of the JOBS Act, in what was sometimes a contentious open meeting. The changes to Rule 506–permitting the use of general solicitation and general advertising in a Rule 506 offering provided that the issuer takes reasonable steps to verify that purchasers are accredited investors–were over a year late, and generated a good bit of comment and criticism.

Ultimately, the Commission adopted the Rule 506 changes largely as proposed, noting that the determination of the reasonableness of the steps taken to verify that an investor is an accredited is an objective assessment by the issuer, based on the facts and circumstances of each purchaser and transaction. However, the Commission decided to provide in Regulation D a non-exclusive list of methods that the issuer could use to verify the accredited investor status of individuals, including reviewing copies of any IRS form that reports the income of the purchaser (along with a written representation that the purchaser will likely continue to earn that amount), reviewing bank statements, brokerage statements, CDs, tax assessments, appraisal reports and consumer reports with respect to net worth, or by receiving a written confirmation that a specified third party has taken reasonable steps to verify a purchaser’s accredited investor status, including a registered broker-dealer, SEC-registered investment adviser, licensed attorney or CPA.

The SEC also made the parallel changes to Rule 144A that were proposed last year, eliminating references to “offer” and “offeree,” and thus requiring only that the securities are sold to a QIB or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a QIB in a Rule 144A transaction. Form D was also amended to add a separate checkbox for the new paragraph (c) of Rule 506.

The Commission helpfully reaffirmed in the adopting release that Title II of the JOBS Act did not represent a Congressional intent to eliminate the existing “reasonable belief” standard in Rule 501(a) or for Rule 506 offerings (thus the accredited investor determination is not subject to an absolute standard). The Commission also reiterated the interpretive guidance that the effect of Title II is “to permit private funds to engage in general solicitation in compliance with new Rule 506(c) without losing either of the exclusions [3(c)(1) and 3(c)(7) under the Investment Company Act.”

Commissioner Aguilar opposed the adoption of the amendments, noting in his statement that the process for adopting the amendments and the amendments “come at the expense of investors and place investors at greater risk.”

The amendments are effective 60 days after publication in the Federal Register. The SEC provided Fact Sheets for each piece of yesterday’s rulemaking package: the Rule 506 changes, the Regulation D proposal and the bad actor rules.

More Regulation D Changes Proposed

The SEC also proposed several changes to Regulation D that would help the Commission monitor the impact of Title II on the offering market and the offering practices which develop under the rule. This proposal addresses some of the concerns of commenter raised regarding the Rule 506 proposal. Under these proposals, issuers relying on Rule 506(c) to engage in general solicitation in connection with the offering would have to file a Form D 15 calendar days before commencing the offering, and file an update to the Form D information within 30 days of completing the offering. Additional information would also be required in the Form D about the issuer and the offering. If an issuer fails to file a Form D, the issuer and the issuer’s affiliates would be disqualified from using the Rule 506 exemption in any new offering for one year beginning after the required filings are made. Finally, these proposals would require that legends and cautionary statements be included on any written general solicitation material (including special rules for private funds), and that written general solicitation materials be submitted to the SEC, while the guidance in Securities Act Rule 156 would be extended to private funds. This proposal is out for a 60-day comment period.

This proposal drew sharp criticism from Commissioner Gallagher and Commissioner Paredes, who viewed the proposal as undermining what Title II was trying to accomplish.

A Blast from the Past: The Rule 506 Bad Actor Disqualification Provisions

As part of the overall package of rulemaking yesterday, the SEC followed the suggestion of some commenters on the Title II rules and adopted the Dodd-Frank Act mandated bad actor disqualification provisions. As noted by Anna Pinedo in this Morrison & Foerster blog, the final rules were largely adopted as proposed, except for modifications to the categories of persons covered; modifications to the types of actions that are covered; and modifications to the actions that are covered. The Commissioners unanimously approved these amendments, which were originally proposed back in May 2011.

Another thing that the Commissioners could all agree on yesterday was their praise for Gerry Laporte, who will be retiring from his position as Chief of Corp Fin’s Office of Small Business Policy. During the course of the open meeting, Gerry’s contributions over the years for small businesses and investors were repeatedly recognized.

– Dave Lynn