The U.S. Securities and Exchange Commission is proposing to liberalize the rules governing the marketing of private placements in the United States. The proposed rules are mandated by the Jumpstart Our Business Startups Act (JOBS Act) and would permit issuers to engage in general solicitation and general advertising – such as print advertisements, media broadcasts, website postings and public seminars – in connection with sales of securities to accredited investors1 and qualified institutional buyers.2
Permitting general solicitation and general advertising will expand companies’ opportunities to market private offerings to eligible investors and will reduce the risk of regulatory liability. Of note for Canadian and other issuers conducting cross-border offerings is the SEC’s clarification in the proposal that the relaxed marketing rules will not affect issuers’ ability to combine a U.S. private placement with a public offering outside the United States.
Private Placements to Accredited Investors
The SEC is proposing to amend Rule 506 of Regulation D under the Securities Act of 1933 to permit general solicitation and general advertising in private offerings, provided that the issuer takes reasonable steps to verify that all purchasers of the securities are accredited investors. The obligation to verify accredited investor status is a key component of the rule proposal, but notably, an issuer could still elect to conduct a Regulation D offering without engaging in general solicitation or general advertising. In that case, as under the current rules, the issuer must reasonably believe that all purchasers are accredited investors, but no additional due diligence obligation would be imposed.
The proposed rules do not prescribe specific methods or steps an issuer would have to take to verify that a purchaser is an accredited investor. Instead, the reasonableness of an issuer’s due diligence would depend on the facts and circumstances of each transaction, taking into account factors such as the nature of the purchaser and the type of accredited investor the purchaser claims to be; the amount and type of information that the issuer has about the purchaser; the manner in which the purchaser was solicited; and the terms of the offering (for example, a minimum investment amount). In general, the more broadly marketed an offering is and the less information an issuer has about a potential investor, the greater will be the issuer’s due diligence obligation to confirm accredited investor status. The SEC proposal states that, in all cases, issuers would have to retain adequate records of their due diligence procedures.
The SEC enumerates several sources of information that an issuer might use to determine whether potential investors qualify as accredited investors. These sources include publicly filed documents such as SEC or other regulatory filings, tax records provided by the potential investor, and information from third parties such as dealers, attorneys or accountants, provided that the issuer has a reasonable basis for relying on the third party. The SEC stated that the proposed new marketing rules could result in the development of innovative approaches to meeting the verification requirement, such as the creation by third parties of databases of accredited investors.
Rule 144A Offerings to Qualified Institutional Buyers
The proposed rules would also permit general solicitation and general advertising in connection with Rule 144A offerings to QIBs. Notably, the heightened verification requirements described above would not apply to these offerings. However, the issuer and anyone acting on its behalf, such as a dealer, would have to reasonably believe that all purchasers are QIBs, and Rule 144A already provides a non-exclusive list of methods that issuers may use to establish an entity’s ownership of and discretionary investments in securities.
Private Equity and Hedge Funds
Private equity funds, hedge funds and other privately offered funds will be able to take advantage of the liberalized marketing rules. The SEC clarified in its rule proposal that such funds would be able to engage in general solicitation and general advertising in connection with private offerings of securities, and this would not jeopardize the fund’s exemption from regulation under the Investment Company Act.
Implication for Cross-Border Transactions
In Canada, the Ontario Securities Commission is currently engaged in a broad review of the private placement market and there has been an increased focus by Canadian regulators on issuers’ and dealers’ compliance with prospectus exemption requirements, including due diligence methods for confirming investor eligibility. In the public offering context, Canadian regulators have proposed rule changes that would permit issuers and dealers to use a wider range of marketing materials alongside the prospectus, although these rules would be more restrictive than the U.S. rules permitting free-writing prospectuses.
On the one hand, there remain important differences between the Canadian and U.S. marketing rules for public and private offerings that require planning cross-border transactions with a view to compliance with the restrictions in each jurisdiction. On the other hand, current regulatory developments will be incrementally beneficial for certain cross-border offerings. For example, in the context of a transaction involving a Canadian public offering combined with a U.S. private placement, the SEC’s proposal to permit general solicitation and general advertising would reduce concerns about publicity or marketing in Canada violating U.S. private placement rules.
1 Accredited investors include banks and certain other financial institutions; broker-dealers; insurance companies; investment companies; corporations and certain other entities with assets in excess of US$5 million; directors, executive officers and general partners of the issuer; natural persons whose net worth, or joint net worth with their spouse, exceeds US$1 million (excluding the value of the primary residence); and natural persons whose income exceeds certain thresholds.
2 Qualified institutional buyers (QIBs) include investment companies, insurance companies, corporations and certain other entities that own and invest on a discretionary basis at least US$100 million in securities of unaffiliated issuers; dealers that own and invest on a discretionary basis at least US$10 million in securities of unaffiliated issuers; and banks with a net worth of at least US$25 million and that own and invest on a discretionary basis at least US$100 million in securities of unaffiliated issuers. All QIBs also qualify as accredited investors.
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