In a historic and long-anticipated move to make private placements less “private,” the Securities and Exchange Commission (SEC) recently adopted final rules allowing general solicitation and general advertising in private placements so long as:
- The issuer takes reasonable steps to verify that the investors are “accredited investors;” and
- All investors meet the requirements of accredited investors or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
Issuers can offer the securities to anyone, through any medium, including the Internet or any social media, even if they do not qualify as an accredited investor, so long as only accredited investors actually purchase the securities. The SEC is also maintaining the existing regime of Regulation D private placements, which includes investors below the accredited investor minimums but without any public advertising or solicitation.
Accredited investors generally are natural persons whose individual net worth with their spouse exceeds $1 million, excluding the value of their home and any related indebtedness. It also includes an individual with net income of greater than $200,000 ($300,000 when combined with that of their spouse) in each of the last two years with a reasonable expectation to meet that level in the current year. There are separate categories for entities, like partnerships and limited liability companies.
“Reasonableness” is an objective assessment by the issuer, considering the facts and circumstances of each purchaser and the transaction, including:
- Nature of purchaser and type of accredited investor that it claims to be;
- Amount and type of information issuer has about the purchaser; and
- Nature of the offering, such as manner in which purchaser was identified, and terms of offering, like minimum investor amount.
The SEC provides a non-exclusive list of methods issuers can use to satisfy the verification process, including reviewing copies of IRS forms that report income plus a written representation that the purchaser will likely continue to earn the necessary income in the current year. Additionally, the issuer can satisfy the requirements by receiving a written confirmation from a registered broker-dealer, SEC registered investment adviser, licensed attorney or certified public accountant that an entity or person has taken reasonable steps to verify the purchaser’s accredited status within prior three months.
The SEC also amended Rule 144A so that securities sold pursuant to Rule 144A can be offered to persons other than Qualified Institutional Buyers (QIBs), including through general solicitation, provided that the securities are only sold to persons whom the seller and any person acting on behalf of the seller reasonably believes is a QIB.
Form D was also amended so that a box on the form was added for issuers to check if claiming the exemption that permits general solicitation and general advertising. Form Ds are required to be filed with the SEC for all securities offerings under Regulation D within 15 days after the first sale of securities in the offering. These new rules will be effective on Sept. 23, 2013. The SEC also adopted rules to exclude felons and certain “bad actors” from participating in certain exempt securities offerings.
These much anticipated and long overdue rule changes carry many implications for capital formation. Here are 10 of the most notable implications to ponder:
1. Increased market size
The SEC estimates that 8.7 million households, or 7.4 percent of all U.S. households, qualify as accredited investors in 2010 based on the net worth standard, yet fewer than 234,000 investors (unknown how many are actually natural persons) participated in regulation D offerings in 2012. There is a large and growing market for these new “public placements.” Those who figure out how to tap that market will be very successful.
2. Advertising
Issuers will be able to make securities offerings through any media, TV, newspapers, web sites, social media (Twitter, Facebook, etc.) and mass emails. Is web advertising for securities different than other web advertising? Will it develop like for the market for prescription drugs? Will we grow to hate these ads as much as those for Viagra? Many companies are creating web portals or various designs in an attempt to match issuers with potential investors.
3. New Verification Services
Third-party services will develop up to meet the “verification” requirements, granting accredited investor status “stamps of approval” for three months enabling that entity or person to invest. For example, credit reporting bureaus will likely grant status based on currently possessed information, together with self-certifications. They and others will also likely create databases of potential pre-screened investors.
4. Speed Advantage
Some public offerings may move to private placements, shorting the time to collect funds and reducing the cost and complications of their offerings. Many non-traded REITs could likely pursue these public placements as the disadvantages of an SEC-registered process will outweigh the advantages of a new “going private” offering. Advantages of public offerings will diminish perhaps, leading to more non- public private placements.
5. Boost to Private Equity
Private equity and hedge funds will begin marketing to the public. Whole industries will crop up assisting hedge funds and other pools of capital to obtain and keep public investors. Consultants and brokers may help individuals make sense of this new onslaught. The advertising blitz behind the introduction of mutual funds will dwarf the rush toward these new public offerings.
6. Business Decisions
Firms with access to pools of capital, like large brokerage or money manager firms, will have to decide how to incorporate these new public offerings to their customers and clients, for retirement funds or otherwise.
7. Fraud Concerns
Fraud may increase, but hopefully the market will correct itself. The new rules exclude “bad actors” from participating so maybe that will cut down on the fraudsters.
8. Change in Confidentiality Practices
Private placements often require the signing of non- disclosure or confidentiality agreements. Some issuers may change or limit the amount of information they provide in some of their more public placements because of their concerns of the public dissemination of their proprietary information. This may even lead to two or more tiers of investment based in part on amount and timing of disclosure.
9. Navigating the Regulatory Scheme
Private fund sponsors and their funds may have difficulty harnessing the full impact of the new rules because the complicated juncture of the Commodity Exchange Act, and the Investment Advisers Act, among others. Private funds can engage in general solicitation without losing exclusions under the Investment Company Act. The participants may evolve in the ways that they raise capital.
10. Financial Boon to Issuers
The SEC acknowledges that the new rules will lower the cost to raise capital. Only 11 percent of all new Reg D offerings listed sales commission from 2009 to 2012. And the average commission was 5.9 percent, so for a $5 million offering, which was the median size during that period with commission, an issuer could save up to $250,000 if it solicits investors directly, minus its own direct solicitation costs. Issuers raising up to $1 million paid 6.4 percent commission; over $50 million paid 1.9 percent commission.
Finally in a separate release, the SEC proposed a fairly radical overhaul of the Form D, including much more comprehensive information and adding a pre-offering filing, to coincide with a post-offering filing, requirement. The SEC is seeking comment on these proposals.