Hedge Fund Solicitation Ban Lifted by SEC
Investment Management Update
Date: July 12, 2013
The Jumpstart Our Business Startups Act, which was enacted in April 2012, directed the United States Securities and Exchange Commission (SEC) to eliminate the prohibition against general solicitation or general advertising in any offering of securities pursuant to Rules 506 or 144A under the Securities Act of 1933, as amended (Act), provided that the sales are made to “accredited investors” (or “qualified institutional buyers,” or persons reasonably believed to be “qualified institutional buyers,” in the case of Rule 144A) and the issuer takes reasonable steps to determine that the purchasers are “accredited investors.” The Act does not define “general solicitation” or “general advertising.” However, Rule 502 under the Act provides examples, including advertisements in newspapers or magazines, or communications over television or radio. The SEC issued proposed rules on August 29, 2012 which generated comments on the steps needed to verify whether purchasers of securities are “accredited investors.” On July 10, 2013 the SEC adopted amendments (Final Rule) to Rules 506 and 144A under the Act which eliminate the prohibition on general solicitation or general advertising in Rule 506 offerings and in the resale of securities pursuant to Rule 144A, and provide guidance on how an issuer of securities can verify purchasers of securities are “accredited investors.”
Reasonable Steps to Verify Purchasers are “Accredited Investors”
The Final Rule adds new paragraph (c) to Rule 506 which states that the prohibition against general advertising or general solicitation shall not apply provided that all purchasers of the securities are “accredited investors” and the issuer takes reasonable steps to verify that such purchasers are “accredited investors.” The Final Rule provides a nonexclusive list of steps that an issuer may take in determining “accredited investor” status: 
- if the purchaser is a natural person, an issuer is deemed to have satisfied the verification requirement by reviewing copies of Internal Revenue Service forms that report income including W-2, Form 1099, Schedule K-1 and Form 1040 for the two most recent years, along with a written representation from such person that he/she has a reasonable expectation of reaching the required income level to qualify as an “accredited investor” for the current year;
- if the purchaser is a natural person, an issuer is deemed to have satisfied the verification requirement by reviewing bank statements, brokerage statements and other statements of securities holdings, in each case, dated within the past three months along with a written representation from such person that all liabilities to determine net worth have been disclosed;
- an issuer is deemed to have satisfied the verification requirement by obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, licensed attorney or certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an “accredited investor” within the three prior months, and such purchaser is an “accredited investor;” or
- if the purchaser is a natural person who invested in an issuer’s Rule 506(b) offering as an “accredited investor” prior to the effective date of Rule 506(c), the issuer is deemed to have satisfied the verification requirement by obtaining a certification from such person that he/she qualifies as an “accredited investor” at the time of the 506(c) offering.
For all other purchasers, the Final Rule proposes a principles-based method of verification and the “reasonable steps” shall be an objective determination by the issuer depending on the facts and circumstances. Among the factors to be considered are the nature of the purchaser and the type of accredited investor such purchaser claims to be, the amount of information the issuer has regarding the purchaser and the nature of the offering. Based on the facts and circumstances, the more likely it is a purchaser is an accredited investor, the fewer the steps required by the issuer, and vice versa. 
Sales of Securities under Rule 144A
The Final Rule amends Rule 144A such that any resales of securities may be conducted by means of general solicitation or general advertising provided that all resales under Rule 144A are made to a “qualified institutional buyer,” or QIB, or any person reasonably believed to be a QIB.
It should be noted that the Final Rule makes clear that the elimination of the prohibition on general solicitation or general advertising does not extend to other offerings under Section 4(a)(2) under the Act or Rule 506(b) under the Act.
Proposed Rule for Filings on Form D
The SEC has issued a proposed rule (Proposed Rule) requiring issuers to file a Form D 15 days in advance of an offering pursuant to which such issuer has engaged in general solicitation or general advertising. The Proposed Rule would also require issuers to provide additional information regarding the offering including the issuer’s website, offered securities, types of investors and use of proceeds. Additionally, the Proposed Rule disqualifies issuers who fail to file Form D from using Rule 506, requires issuers to include cautionary information in any written general solicitation materials used, and to submit such written general solicitation materials to the SEC (the requirement to submit materials would be temporary and expire after two years).
FOR MORE INFORMATION
For further information about the Final Rule and/or Proposed Rule, please contact:
Richard S. Heller
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 The SEC has confirmed that other uses of public media, such as unrestricted websites, also constitute “general solicitation” or “general advertising.” see Use of Electronic Media for Delivery Purposes, Release No. 33-7233 (Oct. 6, 1995) [60 FR 53458, 53463-64 (Oct. 13, 1995)]; Use of Electronic Media, Release No. 33-7856 (Apr. 28, 2000) [65 FR 25843, 25851-52 (May 4, 2000)].
 All the requirements under Rule 501 and Rules 502(a) and 502(d) must be satisfied in any offering by means of general advertising or general solicitation.
 An issuer may not rely on the safe harbor verification steps if such issuer or its agent has knowledge that the purchaser is not an “accredited investor.”
 For example, an offering for which the minimum investment is high enough such that only an “accredited investor” could make the investment would require fewer steps than would otherwise be required of the issuer.