July 10, 2013, the same day the SEC adopted final rules eliminating the prohibition against general solicitation and advertising in Rules 506 and 144A offerings as required by Title II of the JOBS Act, and adopted new rules disqualifying felons and other bad actors from participating in Rule 506 offerings as required by Section 926 of the Dodd-Frank Act, the SEC issued proposed rules further amending Regulation D, Form D and Rule 156. On August 19, 2013, I published a blog detailing the proposed rule changes related to Form D and Rule 507. This Part II addresses the proposed amendments to general solicitation materials, including the temporary requirement that all such materials be submitted to the SEC.
Summary of Proposed Rule Changes
The proposed amendments will (i) require the filing of a Form D to be made before the Issuer engages in any general solicitation or advertising in a Rule 506(c) offering and require the filing of a closing amendment to the Form D at the termination of the offering; (ii) require that all written general solicitation material used in a Rule 506(c) offering include certain legends and disclosures; (iii) require that all written material used in general solicitation and advertising be submitted to the SEC; (iv) disqualify an Issuer from relying on Rule 506 for one year for future offerings if the Issuer, or any predecessor or affiliate of the Issuer, failed to comply with the Form D filing requirements for a Rule 506 offering in the last five years; (v) amend the Form D to include additional information about offerings; and (vi) amend Rule 156 to extend the antifraud guidance in the rule to include sales literature of private funds (hedge funds). In addition, as part of the proposed rule release, the SEC is seeking comments from the public on the definition of “Accredited Investor.”
Proposed New Rule 509
The SEC has proposed a new Rule 509 of Regulation D which would require all Issuers to include prescribed legends in any written communication used in general solicitation in a 506(c) offering. The new Rule 509 would require all Issuers to include the following legends, prominently placed, on all written general solicitation materials:
- The securities may be sold only to accredited investors, which for natural persons are investors who meet certain minimum annual income or net worth thresholds;
- The securities are being offered in reliance on an exemption from the registration requirements of the Securities Act and are not required to comply with specific disclosure requirements that apply to registration under the Securities Act;
- The Commission has not passed upon the merits of or given its approval to the securities, the terms of the offering, or the accuracy or completeness of any offering materials;
- The securities are subject to legal restrictions on transfer and resale, and investors should not assume that they will be able to resell their securities; and
- Investing in securities involves risk, and investors should be able to bear the loss of their investment.
In addition to each of the above legends, private funds, such as hedge funds, would also be required to include a legend disclosing that the securities being offered are not subject to protections under the Investor Company Act of 1940. Moreover, the new rule would require any private fund written general solicitation materials that include performance data to also include a legend disclosing that:
- Performance data represents past performance;
- Past performance does not guarantee future results;
- Current performance may be lower or higher than the performance data presented;
- The private fund is not required by law to follow any standard methodology when calculating and representing performance data;
- The performance of the fund may not be directly comparable to the performance of other private or registered funds; and
- Identification of either telephone number or website where an investor may obtain current performance data.
All performance data used in solicitation materials must be from the most recent practicable period and dated. The data must include disclosure as to whether the numbers are gross or net of fees and expenses. Other than these legend and disclosure requirements, and of course general antifraud provisions, there are no current or proposed content restrictions on solicitation materials for private funds, including hedge funds. However, the SEC has requested public comment on such possible restrictions and may impose them in the future.
Although a failure to comply with this rule does not automatically disqualify the 506(c) exemption, a failure to comply resulting in an order or judgment would disqualify the Issuer from relying on Rule 506 for future offerings.
Importantly, written general solicitation material is and remains undefined in the proposed rule. The SEC has requested comment as to whether such a definition should be added to the rules and if so, whether such definition should match current Rule 405 related to registered offerings. Rule 405 defines “written communications” as any communication that is written, printed, a radio or television broadcast, or a graphical communication. Graphical communication includes all forms of electronic media, including, but not limited to, audiotapes, videotapes, facsimiles, CD-ROMs, e-mail, Internet websites, telephone answering or voice mail systems, and basically all computer-generated information.
Clearly, most issuers, including reasonably well-educated executives, would not consider radio and TV ads or audio or videotapes to be written solicitations. However, securities attorneys and practitioners familiar with Rule 405 will likely defer to it as guidance in applying the legend placement requirements. Accordingly, if the rule does pass as written, I suspect a broad disparity in its application.
Proposed Amendments to Rule 156
Rule 156 provides guidance on the types of information in investment company sales literature that could be misleading. The SEC has proposed to amend Rule 156 to extend the antifraud guidance in the rule to specifically include the sales literature of private funds (hedge funds). Rule 156 applies to all funds, whether engaged in an offering under Rule 506(c) or otherwise. The rule amendment is intended to specifically address concerns about (i) advertising performance without providing information about unusual or extraordinary circumstances that might have affected that performance; (ii) advertising performance without providing adequate disclosure of the performance period or current information; and (iii) advertising performance based on selective time periods without providing disclosure regarding the full picture including all current time periods.
Additional Rules Relating to Advertising Materials of Private Funds, Including Hedge Funds
Other than as discussed herein, neither the current rule nor proposed rules provide specific restrictions on either the manner or content of general solicitation materials used solely by private funds. The SEC is requesting comment on whether such rules should be implemented.
Private funds are not subject to standardized performance calculations or reporting requirements. Moreover, private funds securities tend to be more illiquid and more difficult to evaluate. Accordingly, even if materials are true and correct, they can be confusing to investors looking to compare the results of different funds in making an investment decision.
As there are legitimate reasons for using different methods of valuation, the SEC is not proposing standardized calculations or valuation rules at this time. However, the SEC is seeking comments on whether other rules relating to the manner or content of private funds solicitations are appropriate. Examples of rules may be the prohibition of including performance materials or additional information regarding performance calculations, or requiring additional investor sophistication beyond being accredited for hedge fund investors.
Proposed Rule for the Temporary Mandatory Submission of Written General Solicitation Materials
The SEC has proposed new temporary Rule 510T to require issues to temporarily submit all written general solicitation materials used in their Rule 506(c) offerings to the SEC no later than the date of the first use of such materials. Materials would be submitted electronically through a portal on the SEC website established for this purpose. This rule is temporary in that it is meant to provide the SEC with information and research materials to better monitor the use of new Rule 506(c) and ascertain rules and guidance that may be required in the future. The proposed rule would expire two years after effectiveness.
Submissions under proposed Rule 510T would not be treated as filed or furnished for purposes of the Securities Act or Exchange Act and therefore would not be subject to the liability provisions for such filings. Like proposed Rule 509, a failure to comply with Rule 510T will not automatically disqualify the 506(c) exemption; however, a failure to comply resulting in an order or judgment would disqualify the Issuer from relying on Rule 506 for future offerings.
As with Rule 509, written general solicitation material is and remains undefined in the proposed rule 510T. The SEC is requesting comment on whether a definition of written materials should be included, and in reading the comments thus far submitted on the proposed rule, it is clear that some guidance is needed. Some practitioners have automatically assumed that the proposed Rule would encompass the same definition of written materials as Rule 405, and others have assumed otherwise.
Most commenters have three objections to the rule. One is that the Rule is too broad and burdensome and Issuers simply will not abide by the Rule, or will only partially abide. The second is that the SEC does not have the technological capability to handle the influx of information and materials that will flood the system and the SEC site will crash. The third objection is that the SEC will not have the staff or ability to actually review the bulk of the information provided and accordingly, the purpose of the Rule—to provide the SEC with information for future rule making—will be obfuscated.
Request for Comment on the Definition of “Accredited Investor”
The SEC believes the definition of “Accredited Investor,” as it relates to natural persons, needs to be amended. The SEC is considering changes to both the net worth and income tests for accredited investors and even adding non-monetary criteria such as investment experience.
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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 For example, the 1940 Act includes limitations on self-dealing, affiliated transactions and leverage, and board independence requirements, none of which apply to private hedge funds.