SEC Lifted Ban on General Solicitation – What does it Mean in EB-5 Practice?
Yi Song, Esq.
On July 10, 2013, the Securities and Exchange Commission (SEC) adopted a new rule under the JOBS Act, which repeals the prohibition on general solicitation for private securities offerings relying on Rule 506 of Regulation D exemption.
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This is certainly exciting progress for the capital raise in EB-5 projects. Since the former SEC Chairwoman, Mary Shapiro, stepped down, many believed that the implementation of the JOBS Act would be postponed indefinitely. Rule 506 of Regulation D is the most widely-used exemption for EB-5 projects to raise capital. It exempts the projects from registering with the SEC and allows the projects to raise unlimited amount of capital from unlimited number of accredited investors. According to the SEC statistics, in 2012 the companies relying on Regulation D exemption raised capital 4 times more than initial public offerings (IPO).
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The new rules will make securities law in EB-5 practice critical, almost as important as the economic report in the job creation. The EB-5 regional centers and projects must retain securities counsel to file the Form D and to advise on the general solicitation activities, or else the EB-5 regional centers and projects could face serious consequences, including being disqualified from Rule 506 of Regulation D exemption. If the new rule proposal is adopted, the EB-5 regional centers and projects who utilize the general advertisement to solicit investors shall retain securities counsel to draft and review the written materials for the general solicitation marketing activities. The said written materials shall be submitted to the SEC and meet the requirement listed in securities law guidance for sales literature.
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In relation to this new rule, the Commission voted to issue a rule proposal requiring issuers to provide additional information about these securities offerings and the securities issuers. By lifting the ban on general solicitation, the new SEC rules impose stronger obligation on the issuers to file notices with the Commission in advance, to provide more detailed information about the issuer and the offering. The issuer is disqualified from using the Rule 506 exemption in any new offering if the issuer or its affiliates did not comply with the Form D filing requirements in a Rule 506 offering. The disqualification would continue for one year from the date the required Form D filings are made.
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Under the new rule proposal, an EB-5 regional center or EB-5 project can be disqualified from making the private offering and having the capital raise terminated if they fail to file the Form D.
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The new rule proposal also requires issuers to comply with the sales literature guidance whether or not they have general solicitation marketing activities. The issuers are required to submit written general solicitation materials to the Commission through an intake page on the SEC website. Materials submitted in this manner would not be available to the general public. As proposed, written materials requirement would be temporary, expiring after two years. The new rule amendments become effective 60 days after publication in the Federal Register. The proposal is now subject to a 60-day public comment period.
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The New Rule 506
The final rule approved today makes changes to Rule 506 to permit issuers to use general solicitation and general advertising to offer their securities provided that:
- The issuer takes reasonable steps to verify that the investors are accredited investors.
- All purchasers of the securities fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
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Under existing Rule 501, a person qualifies as an accredited investor if he or she has either:
- An individual net worth or joint net worth with a spouse that exceeds $1 million at the time of the purchase, excluding the value (and any related indebtedness) of a primary residence.
- An individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
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The determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each purchaser and the transaction. Nevertheless, in response to commenters’ requests, the final rule provides a non-exclusive list of methods that issuers may use to satisfy the verification requirement for individual investors.
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The methods described in the final rule include the following:
- Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
- Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
The existing provisions of Rule 506 as a separate exemption are not affected by the final rule. Issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren’t subject to the new verification rule.
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New Rule Proposal
The Commission approved a proposal intended to enhance the SEC’s ability to assess developments in the private placement market now that the rule to lift the ban on general solicitation has been adopted. In particular, the proposal would improve the SEC’s ability to evaluate the development of market practices in Rule 506 offerings and would address certain concerns raised by investors related to issuers engaging in general solicitation.
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The proposal requires issuers to file an advance notice of sale 15 days before and at the conclusion of an offering
Currently, an issuer – such as a company or a fund – selling securities using Rule 506 is required to file a Form D no later than 15 calendar days after the first sale of securities in an offering. That form is a type of notice that provides information about the issuer and the securities offering.
Under the proposal, issuers that intend to engage in general solicitation as part of a Rule 506 offering would, in addition to the current requirements, be required to file the Form D at least 15 calendar days before engaging in general solicitation for the offering. Also, within 30 days of completing an offering, issuers would be required to update the information contained in the Form D and indicate that the offering has ended.
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The proposal requires issuers to provide additional information about the issuer and the offering
Currently, Form D requires identifying information about the company or the fund selling the securities, any related persons, the exemption the issuer is relying on to conduct the offering, and certain other factual information about the issuer and the offering.
Under the proposal, issuers are required to provide additional information to enable the SEC to gather more information on the changes to the Rule 506 market that could occur now that the general solicitation ban has been lifted.
The additional information would include:
- Identification of the issuer’s website.
- Expanded information on the issuer.
- The offered securities.
- The types of investors in the offering.
- The use of proceeds from the offering.
- Information on the types of general solicitation used.
- The methods used to verify the accredited investor status of investors.
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The proposal disqualifies issuers who fail to file Form D
Under the proposal, an issuer is disqualified from using the Rule 506 exemption in any new offering if the issuer or its affiliates did not comply with the Form D filing requirements in a Rule 506 offering. As proposed, the disqualification would continue for one year beginning after the required Form D filings are made. Issuers would be able to rely on a cure period for a late Form D filing and, in certain circumstances, could request a waiver from the staff.
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The proposal requires issuers to include legends and disclosures in written general solicitation materials
Under the proposal, issuers are required to include certain legends or cautionary statements in any written general solicitation materials used in a Rule 506 offering.
The legends would be intended to inform potential investors that the offering is limited to accredited investors and that certain potential risks may be associated with such offerings.
In addition, if the issuer is a private fund (a type of pooled investment vehicle) and includes information about past performance in its written general solicitation materials, it would be required to provide additional information in the materials to highlight the limitations on the usefulness of this type of information. The issuer also would need to highlight the difficulty of comparing this information with past performance information of other funds.
The proposal also requests public comment on whether other manner and content restrictions should apply to written general solicitation materials used by private funds.
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The proposal requires issuers to submit written general solicitation materials to the SEC
Under the proposal, issuers are required to submit written general solicitation materials to the Commission through an intake page on the SEC website. Materials submitted in this manner would not be available to the general public. As proposed, this requirement would be temporary, expiring after two years.
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The proposal extends guidance about misleading statements to private funds
Currently, an SEC rule provides guidance on when information in sales literature by an investment company registered with the SEC could be fraudulent or misleading for purposes of the federal securities laws.
Under the proposal, this guidance – contained in Rule 156 under the Securities Act – would be extended to the sales literature of private funds. It would apply to all private funds whether or not they are engaged in general solicitation activities. In the proposing release, the SEC would express its view that private funds should now begin considering the principles underlying Rule 156.
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