The General Solicitation Amendment to Rule 506
To implement the mandate of the JOBS Act, the Commission has divide Rule 506 into two separate exemptions: Rule 506(b) and Rule 506(c). Rule 506(b) continues the exemption, previously provided by Rule 506, which permits sales to up to 35 sophisticated investors and an unlimited number of accredited investors and prohibits general solicitation and advertising. The new Rule 506(c) permits the use of general solicitation and advertising, subject to the following conditions:
All terms and conditions of Rule 501, Definitions, and Rule 502(a), integration with other offerings, and Rule 502(b) information requirements apply, and the securities issued in the offering are restricted within the meaning of Rule 144.
All purchasers of the securities, but not offerees, must be accredited investors in Rule 501. The definitions also includes persons that the issuer reasonably believes to qualify as an accredited investor.
The issuer must take reasonable steps to verify that all purchasers are accredited investors.
The Release makes it unequivocal that, as required by the JOBS Act, Rule 506(c) will be treated as a private placement exemption even though general solicitation and advertising will be permitted; however, the statutory private placement exemption provided by Section 4(a)(2) of the Act (previously enumerated Section 4(2) and which most practitioners view as the safety net in case the Rule 506, now Rule 506(b) exemption fails) continues to be conditioned on the absence of general solicitation and advertising. Thus Section 4(a)(2) is not the parallel statutory exemption to Rule 506(c) offerings but is in the traditional, but renumbered, Rule 506(b) offerings.
Significantly, the Release also makes it unequivocal that, because offerings conducted pursuant to Rule 506(c) are deemed by the JOBS Act to not involve a public offering, hedge funds, private equity funds, venture capital funds and similar private funds may sell their securities using general solicitation and advertising under Rule 506(c) without losing their ability to qualify for exemptions from registration in the Investment Company Act of 1940, which are conditioned on the fund not making a public offering of securities.
Except for limited transition rules, discussed below, an issuer cannot rely on both Rule 506(b) and Rule 506(c) in the same offering. The long standing integration rules for determining what constitutes a separate offering remain in effect.
An issuer that commenced a Rule 506 offering before the effective date of the new Rule 506(c), may choose to use either Rule 506(b) or Rule 506(c) for the portion of the offering conducted after the effective date of the new rule. Ise pf Ri;e 506(c) will not impact the availability of Rule 506(b) for sales in the same offering that were made to investors, both sophisticated and accredited, before the effective date of Rule 506(c).
Bad Actor Amendments to Rule 506
The "bad actor" provisions have been added as new paragraph Rule 506(d). These new provisions disqualify an offering from utilizing the Rule 506 exemption from registration, if certain persons related to the issuer or the offering have engaged in specified "bad acts." This disqualification applies to offerings under Rule 506(b), the old Rule 506, and Rule 506(c), the new section that permits general solicitation and advertising. The disqualifications provisions apply to the following covered persons ("Covered Persons"):
The issuer, any predecessor of the issuer, and any affiliated issuer.
Directors of the issuer.
Executive officers of the issuers, as well as, other officers of the issuer who participate in the offering. Participation in the offering refers to more than incidental invlolvement, and could include involvement in due diligence, preparation of disclosure document, and communications with prospective investors or other participants in the offering process.
General partners and managing partners of the issuer.
Any beneficial owner of 20% or more of the issue's outstanding voting equity securities, calculated on the basis of voting power.
Promoters connected with the issuer in any capacity at the time of the sale. The term "promoter" is defined in Rule 405 to mean anyone who, alone or together with other, directly or indirectly takes initiative in founding the business, or who in onnection with the founding of the business receives 10% or more of a class of issuer securities or 10% or more of the proceeds from the sale of a class of issuer secuirities.
Any person being paid, directly or indirectly, for soliciting purchasers in the offering, as well as, such person's general partners, managing members, directors, executive officers, other officers participating in the offering, general partners, and managing member of any such investment manager or solicitor or general partner or managing member of such investment manager or solicitor.
Investment managers of issuers that are pooled investment funds, as well as such investment manager's general partners and managing members, and the directors, executive officers, other officers participating in the offering, general partners, and managing members of such investment manager or its general partner or managing member.
Disqualifying Events. Rule 506 is unavailable if any covered person has engaged in any of the following disqualifying events, unless iethe the Commission or the court or regulatory body that issued the relevant order determines that disqualification is not necessry in the particular circumstances and grants a waiver of disqualification. In addition, even if there is a disqualifying event, an offering will not lose the Rule 506 exemption if the issuer can establish that it did not know, and in the exercise of reasonable care based on factual inquiry could not have known, that a disqualification existed.
Criminal Convictions. An offering is disqualified if any covered person was convicted of a misdemeanor or felony (i) in connetion with the purchase or sale of a security; (ii) involving the making of a false filing with the Commission; or (iii)arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser, or paid solicitor of purchasers of securities. A conviction is disqualifying only if it ocurred within five years befor the Rule 506 sale in the case of the issuer, its predecessor, or an affiliated issuer, and ten years before the Rule 506 sale in the case of all other covered persons.
Court Injunctions and Restraining Orders. An offering is disqualified if any covered person is subject to a court order entered within five years before the Rule 506 sale that restrains such person from engaging in any conduct or practice (i) in connection with the purchase or sale of a security; (ii) involving the making of a false filing with the Commission; or (iii)arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser, or paid solicitor of purchasers of securities. A court order is not a disqualifying only if either it was entered into more than five years before the offering (even if it remains in effet at the time of the offering) or if the court order is no longer in effect at the time of the offering, even if entered into within the five year period.
Final Orders of Regulators. An offering is disqualified if any covered person is subject to a final order, including a settlement order, of a state securities regulator, federal or state banking regulator, state insurance regulator, or the CFTC that (i) at the time of the Rule 506 sale bars the person from associating with anentitiy regulated by such regulator, engaging in the business of securities, insurance or banking; or engaging in savigs association or credit union activities; or (ii) is based on a violation of a law or regulation that prohibits fraudulent, manipulative or deceptive conduct and was entered into within ten years befor the Rule 506 sale. Bars are disqualifying for as long as they are in effect, regardless of how long ago they were ordered. by contrast, final order covered in section (ii) above cease to be disqualifying ten years after their entry.
Commission Disciplinary Orders. An offering is disqualified if any Cover Person is subject to a Commission order under specified provisions of the securities laws that, at the time of the Rule 506 sale, (i) suspends or revokes such person's registration as a broker, dealer, municipal securities dealer, or investment adviser; (ii) places limitations on the activities functions, or operations of such person; or (iii) bars such person from being associated with any entity or from participating in an offering of penny stock. Discqualification continues for as long as som ast is prohibited or required to be perfored pursuant to the order. As a result, there is no cut-off date if the order involves a permanent prohibition. However, if the order calls for performing a specific act, suh as paying a penalty, the order is no longer disqualifying once the required act has been full performed.
Commission Cease and Desist Orders. An offing is disqualified if any Covered Person is subject to a Commission oreder entered into within five years befor the Rule 506 sale that orders the person to cease and desist from committing or causing violations or future violations of (i) and sienter based anti-fraud provisions of the federal securities laws, or (ii) Section 5 of the Securitieis Act of 1933.
Suspension or Expulsion from SRO Membership or Association with an SRO Member. An offerin is disqualified if any covered person is susended or expelled from membership in, or suspended or barred from associaiton with, a stock exchange or other self regulatory organization for conduct inconsisitent with just and equitable principles of trade.
Commission Stop Orders. An offering is disqualified if any covered person was an issuer or an underwriter of an offering which, within five years of the Rule 506 sale, was subject to a Commision stop order or order suspending a Regulation A exemption, or is, at the time of the sale. the subject of an investigation or proceeding to determine whether such an order should be issued.
United Stated Postal Service False Representation Orders. An offering is disqualified if any covered person is subject to a United States Postal Service false representation order entered into within five years befor the Rule 506 sale, or is, at the time of the sale, subject to an injunction or temporary restraining order with respect to conduct alleged to constitute a scheme for obtaining money or property through the mail by means of false representation.
Transitions Matters. Disqualifying events that occurred before the effective date of the Rule 506 amendments will not make Rule 506 unavailable. However, a description of any such events must be proided to each purchaser, a reasonable time before the Rule 506 sale. In addition, disqualifying events relating to an affiliated issuer will not disqualify the offering if they occurred before the afffiliate relationship existed.
