The Commission considered a proposed rule mandated by the JOBS Act to eliminate the current prohibition against general solicitation and general advertising in certain securities offerings — particularly offerings conducted under Rule 506 of Regulation D.
Rule 506 is one of the exemptions that has been widely used by U.S. and foreign issuers to raise capital without registering their securities offerings.
In 2011, the estimated amount of capital raised in these types of exempt offerings was just over $1 trillion, which is comparable to the amount of capital raised in registered offerings during this same period.
These figures underscore the importance of these exemptions for companies seeking capital in the United States.
When the Commission adopted Rule 506 more than three decades ago, it said the issuer, or any person acting on its behalf, could use the exemption only if they were not offering or selling securities through general solicitation or general advertising.
The JOBS Act
The JOBS Act directs the SEC to lift this prohibition as well as a similar prohibition contained in Rule 144A of the Securities Act. With respect to Rule 506 offerings, it directs the Commission to permit such general solicitation, provided that all purchasers of the securities are accredited investors.
And it further says that our rule “shall require the issuer to take reasonable steps to verify” an investor’s accredited status, using such methods as determined by us.
In recent years, the need for the prohibition against general solicitation has been the subject of increasing debate, particularly in light of changes in communication technologies. New technologies have caused many to question the feasibility and continued desirability of communication restrictions in private offerings.
This is one of the reasons why, even before Congress enacted the JOBS Act, I had instructed the staff to take a fresh look at the prohibition in Rule 506 and develop ideas to reduce regulatory constraints on capital formation in a manner wholly consistent with investor protections.
Although the JOBS Act and this mandate were enacted before our review was complete, the staff has been focused on implementing the provisions of the Act, including the proposal considered.
The Proposed Rule
The rules we proposed would implement this statutory mandate by permitting issuers to use general solicitation in Rule 506 and Rule 144A offerings.
The proposed rules would require an issuer that uses general solicitation to “take reasonable steps to verify” that all of the purchasers are accredited investors. Whether the steps taken are reasonable would be an objective determination, based on the particular facts and circumstances of each offering and investor. The proposing release explains how this framework would operate. I hope that we will receive comment on this aspect of the proposal most particularly, as it is clear from the statute that taking reasonable steps to verify accredited investor status is part and parcel of permitting general solicitation. The comments we receive will enable the Commission to have the benefit of the views expressed by issuers, investors and other market participants on the proposal before the rules are finalized.
I believe that the proposed rules fulfill Congress’s clear directive that issuers be given the ability to communicate freely to attract the capital they need, while obligating them to take steps to ensure that this ability is not used to sell securities to those who are not qualified to participate in such offerings.
Nonetheless, I recognize that there are very real concerns about the potential impact of lifting the ban on general solicitation. Indeed, some of those concerns were noted in several of the letters submitted as part of our pre-rulemaking JOBS Act comment process. I appreciate the many thoughtful letters suggesting both specific and broad reforms to Rule 506 offerings and Regulation D more generally.
While I believe it will be incredibly important for the Commission to take a thorough look at the private placement market in the future, I think at this point it is appropriate that we undertake this more narrow mandate that Congress placed upon us through the JOBS Act.
That view is furthered by the significant change taking place in the private offering landscape as a result of legislative changes, and these changes will be important for us to consider as we review Regulation D.
The legislative changes range from who can invest, to who can use the exemption, to how the offerings are conducted, to the consequences of completing private offerings.
For instance, the Dodd Frank Act changed the accredited investor net worth test for Regulation D offerings by eliminating the investor’s primary residence from the calculation. That same provision prohibits us from changing the net worth test before July 2014.
The Dodd Frank Act also addresses the process for how we determine who is an accredited investor under our rules, and it directs us to undertake a review of the definition as it relates to natural persons in its “entirety” beginning four years after the enactment of the Dodd-Frank Act to determine whether the definition should be adjusted.
It also tasked the GAO with conducting a study about the accredited investor definition, which is required to be completed by next summer.
And, under Dodd Frank, we are required — and have proposed rules — to prohibit bad actors from using Rule 506. I hope we can complete those rules soon.
In addition, the changes mandated by the JOBS Act could well have a very significant impact on the private offering market, which we should consider in connection with any review of Regulation D. The Act also significantly raises the thresholds for when companies have to start reporting with the SEC, which will allow companies to remain private for much longer, with many more investors, than they have in the past. That, combined with new offering techniques and secondary trading mechanisms – like online secondary trading platforms for private companies – could pose very significant challenges for investor protection in these markets.
That is why it is very important for the Commission to study the changes, analyze the impact on investors, issuers and the markets, and take up any needed reforms. While I’m prepared to bring forward the narrow proposal, I look forward to the continued examination of this critically important market.