The Securities and Exchange Commission (SEC) on Wednesday put out for public comment its controversial proposal on private-offering promotion under the JOBS Act.
After repeated complaints, SEC Chairwoman Mary Schapiro decided to back away from issuing the rule and instead put the rule out for public comment. The agency was barraged with complaints from groups like the North American Securities Administrators Association (NASAA) and Americans for Financial Reform (AFR) for circumventing its traditional practice of putting rules out for comment before issuing them.
The Commission will seek public comment on the proposed rules for 30 days.
At an open meeting on Wednesday, Schapiro said that 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, she said, “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, she continued, “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, the agency 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," Schapiro explained.
But the Jumpstart Our Business Startups (JOBS) Act directs the SEC “to lift this prohibition as well as a similar prohibition contained in Rule 144A of the Securities Act,” she said, and with respect to Rule 506 offerings, the Act “directs the Commission to permit such general solicitation, provided that all purchasers of the securities are accredited investors.”
The JOBS Act further says that the SEC’s rule “shall require the issuer to take reasonable steps to verify” an investor’s accredited status, using such methods as determined by the agency.
NASAA President Jack Herstein wrote in a recent blog for AdvisorOne that Rule 506 allows certain private placements to be sold to investors without SEC registration. “By definition, these are limited investment offerings that are highly illiquid, generally lack transparency and have little regulatory oversight,” Herstein wrote.
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, the SEC explains.
“Whether the steps taken are reasonable would be an objective determination, based on the particular facts and circumstances of each offering and investor,” Schapiro said. 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,” Schapiro continued. “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.”
Schapiro said that while she believes “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.”
Regulation D Changes
Schapiro also noted the "significant change" taking place in the private offering landscape as a result of legislative changes, which will be important for the SEC to consider as it reviews Regulation D—of which Rule 506 is a part—which spells out conditions for selling securities without registering them with the SEC.
The legislative changes range from who can invest, to who can use the registration exemption, to how the offerings are conducted, to the consequences of completing private offerings, Schapiro said.
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 [the SEC] from changing the net worth test before July 2014," Schapiro said.
Dodd-Frank also addresses the process for how the SEC determines who is an accredited investor under its rules, Schapiro continued, and "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."