Client Alert: JOBS Act Offers New Capital Raising Alternatives for Hedge Funds and Startups – Part II
SECURITIES AND CORPORATE FINANCE ALERT
“GENERAL SOLICITATION OR GENERAL ADVERTISING” TO BE PERMITTED IN RULE 506 OFFERINGS
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), a product of rare bipartisan Congressional action and White House support. The JOBS Act contains several provisions intended to make it easier for hedge funds and start-up and emerging companies to access capital markets by, among other things, (i) amending existing federal securities statutes and requiring corresponding changes to SEC regulations; and (ii) preempting certain state laws that otherwise might interfere the JOBS Act’s objectives. This Securities and Corporate Finance Alert summarizes just one of the significant provisions of the JOBS Act, namely, the provision that will enable hedge funds and startup companies to raise capital under SEC Rule 506 by means of “general solicitation or general advertising” in the offers and sales of their securities, as long as the purchasers are “accredited investors.” A previous Robinson Waters & O’Dorisio Securities and Corporate Finance Alert discussed a separate JOBS Act provision—one that will permit “crowdfunding” as a means of raising capital. That Alert can be found here.
General Background—Exemption for Private Offerings Under Rule 506
The federal Securities Act of 1933 and similar state securities laws generally prohibit offers and sales of securities without the registration of those securities, unless the laws provide for an exemption from those registration requirements. Rule 506, adopted by the SEC in 1982 as a part of Regulation D, permits companies to raise capital by selling their securities without the delay and expense of registering those securities with the SEC, as long as the requirements of Regulation D (and other applicable securities laws and rules) are met. Under Rule 506, a hedge fund or other company may issue and sell an unlimited dollar value of its securities to an unlimited number of “accredited investors” and to no more than 35 non-accredited investors (or the issuer must “reasonably believe” that there are no more than 35 non-accredited investors) in a single offering. The term “accredited investor” includes a long list of certain business-law entities and institutions, as well as well-heeled individuals. Non-accredited investors must also, either alone or with the aid of an independent representative, meet certain (unspecified) sophistication requirements.
Among the many conditions that must be satisfied in order to comply with Regulation D is that “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising . . . .” The phrase “general solicitation or general advertising” is not defined in SEC rules, but it is generally interpreted to mean that the issuer or person acting on its behalf (for example, a broker selling the securities) must have a preexisting substantive business-law or personal relationship with the persons to whom the securities are offered. Thus, “cold calling,” newspaper, radio, television, or Internet advertising, or holding meetings or seminars whose attendees have been invited by any general solicitation or general advertising, are prohibited under Regulation D. State securities laws and rules contain similar prohibitions against general solicitation and general advertising.
JOBS Act Change to Rule 506
Title II of the JOBS Act, captioned “Access to Capital for Job Creators,” mandates that the SEC adopt changes to Rule 506 that will eliminate the ban on general solicitation and general advertising, as long as all of the purchasers in a securities offering are accredited investors. The statute also mandates that the SEC adopt rules to require that the issuer “take reasonable steps to verify” that all purchasers are accredited.
This JOBS Act change will no doubt make it easier for hedge funds and other issuers to raise capital, as it will open new pathways to potential investors. The statute also, however, leaves a number of questions open for interpretation (and SEC rulemaking). For example, will the current Rule 506 provision permitting sales of securities to up to 35 non-accredited investors (without general solicitation or general advertising) survive, or will the “new” Rule 506 take its place and require that all sales be made to accredited investors only? In addition, the statute literally mandates that “new” Rule 506 require that the purchasers, in fact, be accredited in order to satisfy the requirements of the new rule. Will the “new” Rule 506 permit offers and sales to whom the issuer “reasonably believes” are accredited, as is currently permitted, even if the issuer turns out, in hindsight, to be in error? Will any form of advertising or solicitation be permitted (for example, Internet, radio, television, newspapers, seminars, billboards), or will some forms of advertising or solicitation (for example, cold calling) still be prohibited? Will hedge funds and other issuers be able to solicit directly, or will the solicitation be required to be conducted through an intermediary, such as a broker? Finally, what, if any, specific “reasonable steps” will hedge funds and other issuers be required to take to verify that all purchasers are accredited? The JOBS Act requires that the Rule 506 changes be adopted by the SEC within 90 days of the enactment of the law (i.e., by July 5, 2012).
Preemption of State Law
Securities issued in a Rule 506 transaction are designated as “covered securities” in the federal Securities Act, meaning that state laws, rules, regulations, orders, etc. relating to registration or qualification of securities and securities offerings do not apply to securities issued under Rule 506. States may still enforce their antifraud laws and regulations against issuers and brokers, and they may still require that the issuer notify them of Rule 506 transactions in their states.
What Startups and Hedge Funds Can do Now
As noted above, the final Rule 506 amendments are not required to be adopted until early July, 2012. There are, however, other exemptions from registration that have been utilized, and that can continue to be utilized, by hedge funds and startup (and other) companies to raise capital. Businesses wishing to raise capital now may wish explore one or more of these alternative exemptions for their capital needs. Our finance group can work with your company to explore the various alternatives for funding its operations and growth.
The information contained in this Article is for information purposes only and does not constitute legal advice for any specific situation. For more information about the subject matter of this Article, please feel free to contact Jeffrey A. Bartholomew at Robinson Waters & O’Dorisio at 303.297.2600. The invitation to contact us is not intended as a solicitation in any jurisdiction in which we are not licensed to practice law.