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Posted on Thursday, March 14 2013 at 1:49 pm by

Nasdaq’s Proposed New Internal Audit Function Requirement

On March 4, 2013, Nasdaq issued a proposed new rule that, if approved by the Securities and Exchange Commission (“SEC”), will require listed companies to establish and maintain an internal audit function.  The proposed rule is open for public comment until 21 days after publication in the Federal Registrar, but it is expected to be approved by the SEC.  It would make this Nasdaq listing requirement similar to that of the NYSE, which already has an internal audit function requirement. 

By requiring an internal audit function, Nasdaq seeks to ensure that a company’s management and audit committee receive ongoing assessments of the company’s risk management processes and system of internal control that are provided independently from the company’s routine accounting and financial reporting regimes.  A company will be allowed to outsource the internal audit function to any third party (other than its independent auditor), but the audit committee must maintain sole responsibility for oversight, and it may not allocate or delegate that responsibility to another board committee.

The proposed rule does not prescribe many other specifics for the implementation of an internal audit function, and it does not indicate how Nasdaq will assess compliance with the requirement, beyond certain matters implicit in Nasdaq’s statement of the audit committee’s oversight responsibility.  That statement makes clear that the audit committee will be expected to arrange periodic meetings with the personnel engaged in the internal audit function (whether they are company employees or personnel of an outsource provider) and with the company’s independent auditors, as a way to ensure both (a) receipt of the types of assessments the rule is targeting and (b) more generally, that the assigned responsibilities, budget, staffing and other aspects of the internal audit function are adequate for it to be effective. 

The proposed rule seems unlikely to impose substantial additional effort on most issuers, and Nasdaq noted that many of its listed companies already have an internal audit function.  However, there are no special provisions to modulate requirements for Smaller Reporting Companies, so those issuers will be subject to the same requirements as all other issuers. 

In any event, many Nasdaq issuers with an existing internal audit function, particularly smaller companies, might benefit from a review of their processes and procedures to make sure this function will operate properly under the new requirement.  Among other things, issuers may want to:

  • Formally designate the individuals (and their requisite qualifications) who comprise the issuer’s internal audit function, whether they are existing or new employees of the issuer or personnel provided by an outsourced arrangement.
  • Consider whether titles or job descriptions of any of the issuer’s employees who have been performing de facto the internal audit function (and who will continue that role) should be updated and expanded to better reflect the Nasdaq requirement.
  • Consider whether lines of reporting responsibility need to be clarified, revised and/or formalized.  (Important issues often arise in integrating or balancing procedures for the requisite independence of personnel who are involved in the internal audit function with a company’s procedures for its routine accounting and financial reporting functions.)
  • Check the Audit Committee’s charter to assure that it reflects the oversight and other responsibility envisioned by the new rule.

If the new rule is approved as proposed, companies listed on Nasdaq on or prior June 30, 2013 will need to comply with the new listing requirement by December 31, 2013. Companies listed on Nasdaq after June 30, 2013 will be required to establish an internal audit function prior to listing.

Posted on Monday, September 17 2012 at 7:55 pm by

SEC Issues Proposed Rules Regarding Elimination of General Solicitation Ban

The Securities and Exchange Commission (the “SEC”) has issued proposed rules that would permit certain forms of “general solicitation” in private offerings made in reliance on Rule 506 of Regulation D or Rule 144A under the Securities Act of 1933 (the “Securities Act”).

Rule 506 Offerings

Rule 506 of Regulation D provides a non-exclusive safe harbor that permits the sale of securities in private placements to certain persons, including purchasers who the issuer reasonably believes are accredited investors and up to 35 other purchasers subject to certain conditions. In addition, offerings made pursuant to Rule 506 are not subject to any state securities registration requirements. Currently, Rule 506 prohibits any form of general solicitation or general advertising in connection with a sale of securities under Rule 506.

The JOBS Act directed the SEC to amend Rule 506 by July 4, 2012, to permit general solicitation or general advertising in Rule 506 offerings, provided the only purchasers of the securities are accredited investors.

The proposed rules would permit general advertisements in connection with Rule 506 offerings if the issuer takes “reasonable steps to verify that the purchasers of the securities are accredited investors” and “all purchasers of securities must be accredited investors, either because they come within one of the enumerated categories of persons that qualify as accredited investors or the issuer reasonably believes that they do, at the time of the sale of the securities”. However, issuers that do not engage in a general solicitation may to continue to adhere to Rule 506 as it currently exists and sell to up to 35 non-accredited investors if general solicitation is not employed.

While the proposed rules require issuers to take “reasonable steps” to verify that purchasers of the securities are accredited investors, they do not specify the methods necessary to satisfy this requirement. The SEC specifically avoided providing specifics in order to provide sufficient flexibility to accommodate different types of transactions and changes in market practices and to avoid the market giving unnecessary weight to any factors the SEC may have otherwise provided. It should be recognized, however, that this approach by the SEC is likely to create uncertainty among issuers as to what steps will be sufficient to comply with the proposed rules.

The proposed rules instead provide that whether the steps taken are “reasonable” would be an objective determination, based on the particular facts and circumstances of each transaction. The proposed rules do, however, provide that an issuer should consider the following factors when evaluating the reasonableness of the steps taken to verify that a purchaser is an accredited investor:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

With regard to the last factor, the proposed rules indicate that an issuer that solicits new investors through a website accessible to the general public or through a widely disseminated email or social media solicitation would likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a database of pre-screened accredited investors created and maintained by a reasonably reliable third party, such as a registered broker-dealer. In the case of website offerings, the SEC does not believe that an issuer would have taken reasonable steps to verify accredited investor status if it required only that a person check a box in a questionnaire or sign a form, absent other information about the purchaser indicating accredited investor status. In the case of a widely disseminated email or social media solicitation, the SEC believes that an issuer would be entitled to rely on a third party that has verified a person’s status as an accredited investor, provided that the issuer has a reasonable basis to rely on such third-party verification. Additionally, the SEC also believes that a purchaser’s ability to meet a high minimum investment amount could be relevant to whether an issuer’s verification steps would be reasonable. For example, the ability of a purchaser to satisfy a minimum investment amount requirement that is sufficiently high such that only accredited investors could reasonably be expected to meet it, with a direct cash investment that is not financed by the issuer or by any other third party, could be taken into consideration in verifying accredited investor status.

Regardless of the particular steps taken, issuers will need to retain adequate records that document the steps taken to verify that a purchaser was an accredited investor. Any issuer claiming an exemption from the registration requirements of Section 5 has the burden of showing that it is entitled to that exemption. However, if a person who does not meet the criteria for any category of accredited investor purchases securities in a Rule 506(c) offering, we believe that the issuer would not lose the ability to rely on the proposed Rule 506(c) exemption for that offering, so long as the issuer took reasonable steps to verify that the purchaser was an accredited investor and had a reasonable belief that such purchaser was an accredited investor.

Effect on Sections 3(c)(1) and 3(c)(7) under the Investment Company Act

Privately offered funds, such as hedge funds, venture capital funds and private equity funds, typically rely on Section 4(a)(2) and the Rule 506 safe harbor to offer and sell their interests without registration under the Securities Act. In addition, privately offered funds generally rely on exclusions from the definition of “investment company” under Section 3(c)(1) and Section 3(c)(7) the Investment Company Act, which enables them to be excluded from the regulatory provisions of that Act. Privately offered funds are precluded, however, from relying on either of these two exclusions if they make a public offering of their securities. The proposed rules provide that SEC believes the effect of the proposed rules is to permit privately offered funds to make a general solicitation without losing either of the exclusions under the Investment Company Act.

Amendment to Rule 144A

Rule 144A provides a non-exclusive safe harbor exemption from the registration requirements of the Securities Act for resales of certain “restricted securities” to qualified institutional buyers (“QIBs”). In order for a transaction to come within existing Rule 144A, a seller must have a reasonable basis for believing that the offeree or purchaser is a QIB and must take reasonable steps to ensure that the purchaser is aware that the seller may rely on Rule 144A. The proposed rules revise Rule 144A to provide that securities sold pursuant to Rule 144A may be offered to persons other than QIBs, including by means of general solicitation, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a QIB. Under the proposed rules, resales of securities pursuant to Rule 144A could be conducted using general solicitation, so long as the purchasers are limited to QIBs.

If you have any questions regarding the matters addressed above, please contact us.

Posted on Tuesday, July 3 2012 at 1:53 pm by

SEC Admits It Will Miss First JOBS Act Deadline

Last Thursday, June 28, Securities and Exchange Commission Chair Mary Schapiro finally made official an open secret – the SEC will miss the July 4th deadline for adopting rules that would lift the ban on general solicitation and advertising for Rule 506 private offerings because the deadline is “not achievable.”

Speaking to a Congressional oversight panel, Chairwoman Schapiro stated: “The 90-day deadline does not provide a realistic timeframe for the drafting of the new rule, the preparation of an accompanying economic analysis, the proper review by the commission, and an opportunity for public input.” She indicated that the Commission would be in a position to issue the rules “in the very near future”, most likely sometime this summer. 

That the rules will not be implemented within the deadline is not the least bit surprising. We and others have long predicted that.  The only surprise is that it took the SEC until the eve of the first deadline under the JOBS Act to admit it.

Also mildly surprising is the positive attitude exhibited by the Commission and Staff towards the herculean rulemaking task imposed by the ambitious JOBS Act, especially since the Chairwoman and other Commissioners had made clear during Congressional debates on the JOBS Act that they considered the deadlines unachievable.  The immense challenge of meeting the JOBS Act’s deadlines, which were blatantly unreasonable on their own, was exacerbated by a host of other factors, such as the Commission’s budget difficulties; the increasing proclivities of Congress, the press, other regulators and the public to blame the SEC for most of the maladies inherent in the capital markets; and heightened judicial scrutiny giving rise to the increased likelihood nowadays of litigation challenging new rules.  One would understand if the SEC were less than enthusiastic in taking on the rulemaking mandates in the JOBS Act. Instead, the attitude of Commissioners and Staff in many public forums has been exemplary, exhibiting a sincere desire to work diligently to implement Congress’ wishes within the timeframes provided.   

Even so, one is left to wonder what missing this first deadline implies for the other upcoming JOBS Act deadlines.  The Act orders the Commission to have rules in place for the crowd-funding provisions within 270 days of the Acts’ enactment.  This is a massive job that contemplates structuring a new offering exemption out of whole cloth, including defining the hitherto unknown “funding portal” and specifying registration procedures for the offering and the funding portal, all with extraordinarily thin guidance from the statute as to how all this is supposed to work. 

Development of the overdue private placement rules, despite their great potential to revolutionize private capital formation, pales in complexity to rulemaking for the crowd-funding rules, leaving many to predict that the promulgation and finalization of these rules may go the way of several of the rules required by the Dodd Frank Act (e.g., pay ratio disclosure requirements), which have not been proposed nearly two years after passage of that legislation.

Posted on Monday, June 25 2012 at 8:37 pm by

Social Media Usage Can Have Reg FD Implications

A recent news headline provided another reminder of both the power of social media to disseminate information, and the dangers of its casual use by public company employees. In this case, a cryptic twitter message led to the firing of a senior executive, perhaps because the tweet raised Regulation FD concerns, or perhaps because it reflected very poor judgment.

In mid-May 2012, Francesca’s Holdings Corporation announced the termination of its CFO after an internal investigation determined that he had improperly communicated company information over twitter. News reports at the time said the CFO posted a tweet that said “Board meeting. Good numbers = Happy Board” during a quiet period prior to the company’s planned earnings release. There is no report of involvement in the matter by the SEC at the time or since.

The exploding popularity of social media – with its temptations to make flippant and less than thoughtful comments, even though they are blasted out to a universe of recipients – should make public companies and their employees leery of using such channels to say anything about their companies. In addition to general concerns about the imprecision and potentially misleading nature of many such communications, there is the potential applicability of Regulation FD (fair disclosure), or Reg FD as it is commonly known. Reg FD prohibits the selective disclosure of material nonpublic information by senior executives and most other company representatives.

The SEC has brought actions under Regulation FD against 11 companies and 12 associated individuals since 2000. Only one of these actions resulted in a judicial decision: SEC v. Siebel Systems Inc., 384 F. Supp. 2d 694 (S.D.N.Y. 2005). In Siebel, the SEC alleged that private statements made by Siebel executives to investors at dinner meetings contained nuanced differences from existing public statements of the company and that this conduct constituted selective disclosure of material nonpublic information.

The U.S. District Court for the Southern District of New York dismissed the entire action on the grounds that the conduct of the Siebel officials did not constitute selective disclosure of material nonpublic information. The court explained that “[t]o be deemed to be material, the statements must contain information of reasonable specificity to impart a definite indicia of performance; and a statement is not material if it constitutes nothing more than a vague assertion on which no reasonable investor would rely.” Id. at 709 n.15.

It is an interesting question whether this, or any other, court would have interpreted the Francesca’s CFO’s brief message as specific enough to support a finding of liability. It seems that the CFO’s message of “Good Numbers,” given the timing and the source, would have been clear enough to cause a reasonable investor to rely on it.

On the other hand, it might be argued that the broad reach of twitter (and many other social media channels) prevents a communication via such media, regardless of its materiality, from being “selectively” disclosed. The practical reach of such channels may be greater than that of a press release or an official SEC filing. Legal recognition of that possible practical reality is not here yet, however. Reg FD defines “public disclosure” as either being included in an 8-K filing with the SEC or dissemination by “another method that is reasonably designed to provide broad non-exclusionary distribution of the information to the public.” Whether social media might satisfy this disclosure requirement has not been the subject of serious public debate to this point.

It is not known if the proactive termination by Francesca of its CFO was prompted by fear of a Reg FD investigation by the SEC or by a more generalized perception of very poor judgment for a company executive to casually disseminate confidential company information to the world. In either case, those in possession of a public company’s material inside information are well advised to guard that information closely, and to recognize that blasting it out via any social media channel is imprudent, at best.

Posted on Friday, June 22 2012 at 4:39 pm by

How “Confidential” is a Confidential Draft SEC Registration Statement Submitted under the JOBS Act?

As we previously discussed in our post on May 16th, the recently enacted Jumpstart Our Business Startups Act (JOBS Act) allows an “emerging growth company” to submit a draft of its IPO (or pre-IPO) registration statement for confidential non-public review and comment by the SEC. We thought we would share with you some potentially interesting questions-and-answers about the confidential submission process.

Will my confidential submission stay confidential forever? While the draft registration statement, amendments and related documents submitted to the SEC pursuant to this confidential submission and review process are initially confidential, they do not remain confidential if a company proceeds with the IPO or pre-IPO offering. The JOBS Act requires that companies publicly file with the SEC the initial confidential submission and all amendments thereto within 21 days prior to the road show (or in the case of an offering that doesn’t include a road show or similar investor communications, 21 days prior to the anticipated effectiveness of the registration statement). These prior confidential submissions should be included as exhibits to the company’s later publicly filed registration statement, if any.

As an example, see the recently filed Form S-1 registration statement of iWatt Inc. iWatt’s initial confidentially submitted draft Form S-1 registration statement is filed as Exhibit 99.1 to its publicly filed Form S-1. No amendments are filed as Exhibit 99.2 et seq., so it would appear iWatt did not submit any confidential amendments.

Will SEC comment letters and company responses remain confidential? Consistent with the SEC’s normal process for comment and response letters, these documents will be made publicly available after the completion of the offering. Specifically, SEC comment letters and company response letters exchanged in connection with the confidential review process will be posted to the SEC’s EDGAR website no earlier than 20 business days following the effective date of the registration statement.

If it won’t remain confidential, why bother submitting a confidential draft registration statement to the SEC? The confidential submission process allows the company to keep the registration statement and its exhibits out of the public domain until the company decides that it is ready to move forward with the offering, if at all. If it abandons the offering before committing to a road show, its submission remains confidential. In this manner, the company can avoid the risk of being perceived by the market as “damaged goods” by dint of abandoning its IPO.

Even if the company goes forward with the offering, and consequently makes its confidential submissions publicly available, we perceive some value to companies in not having to endure the intense microscope of the media on the sometimes painful SEC review process in real-time (although some would say that undergoing that process in the open is beneficial to investors). We note for instance that during its IPO process, Groupon made significant changes to its accounting practices, which drew much contemporaneous media scrutiny. While the JOBS Act confidential submission process ultimately exposes the changes a company may have made during the SEC review process, it only does so after the presumably successful completion of that process.

Can a company publicly announce it is pursuing an IPO while still taking advantage of the confidential submission process for its draft IPO registration statement? Yes. The SEC’s Rule 135 permits public notice of a registered offering, although the content of that notice is fairly limited—you cannot, for instance, identify the underwriters. A number of companies have issued press releases under Rule 135 announcing the confidential submission of a draft registration statement.

Can a company keep anything confidential in its filing or SEC correspondence if it goes forward with the offering? Yes, in a limited fashion. You can use the SEC’s longstanding Rule 406 to try to keep discrete portions of your filing confidential. With respect to SEC correspondence, you can seek to utilize the SEC’s Freedom of Information Act confidentiality procedures.

The traditional confidential treatment procedures are much more limited than the JOBS Act procedure. The JOBS Act permits emerging growth companies to keep an entire registration statement and its exhibits confidential (pending the pre-road show deadline for making them public) without requiring that the company offer any justification for such treatment. Rule 406 on the other hand requires the party requesting confidential treatment to state the grounds for such request and provide a detailed explanation of why, based on the facts and circumstances of the particular case, disclosure of the information is unnecessary for the protection of investors. The specified grounds upon which confidential treatment can be obtained are limited, with the most commonly used exemption being for trade secrets and privileged or confidential commercial or financial information the disclosure of which would cause substantial competitive harm to the company.

Confidential treatment under the traditional procedures can only be obtained for discrete portions of a filing, versus an entire registration statement or exhibit. A typical application of Rule 406 would be to request the omission of a pricing term from a material contract a company is filing as an exhibit to a registration statement.

* * * * * *

The SEC has posted other FAQs on confidential submissions here. Please contact us if you have any questions on the process.

Posted on Tuesday, June 19 2012 at 3:38 pm by

SEC’s Advisory Committee on Small and Emerging Companies Discusses JOBS Act

The Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies met on June 8, 2012, to discuss the recently enacted Jumpstart Our Business Startups (JOBS) Act.

This Committee began considering capital market regulatory issues when it was formed in September 2011, but this was its first meeting since the enactment of the JOBS Act. In prior meetings the Committee recommended: 1) relaxation or modification of the general solicitation ban in Regulation D Rule 506 offerings, 2) an increase in the number of record holders that would trigger public registration and periodic reporting, and 3) an increase in the Regulation A aggregate offering limit. Each of these concepts found their way into the JOBS Act.

The Committee discussed the JOBS Act’s removal of the ban on general solicitation in Regulation D Rule 506 offerings, specifically the requirement that an issuer must take “reasonable steps” to verify that all purchasers are accredited investors and the upcoming SEC rules that will provide guidance on that requirement. The Committee noted that, in determining what constitutes “reasonable steps,” the SEC should consider:

  • the possibility that fraud could be more prevalent in the online subscription context,
  • whether “check the box” investor questionnaires should suffice as verification that a person is an accredited investor, and
  • to what extent the SEC is allowed to regulate the mode/form of soliciting communications without running afoul of the statutory removal of the ban on general solicitation.

The Committee also considered issues arising from the JOBS Act’s increase in the number of shareholders that would trigger registration requirements, particularly the limit of 500 non-accredited shareholders for companies other than banks or bank holding companies. The Committee noted that the SEC is expected to:

  • address the appropriate level of diligence for issuers in performing their annual counting of accredited investors,
  • determine what constitutes an “employee” and “employee compensation” for purposes of the JOBS Act’s exclusion from this shareholder count persons who receive securities under a company employee compensation plan, and
  • consider whether savings and loans and other thrifts are “banks or bank holding companies” for purposes of the JOBS Act.

The Committee did not form any recommendations to the SEC in connection with the SEC’s ongoing implementation of the JOBS Act. Instead, the meeting served as an open forum for the exchange of ideas and possible concerns the SEC may encounter in connection with implementation of the JOBS Act in SEC rulemaking.

Background materials related to the Committee’s recent meeting are available on the SEC’s website at

Posted on Wednesday, May 16 2012 at 3:26 pm by

SEC Updates Procedures for Confidential Submission of Registration Statements by Emerging Growth Companies under JOBS Act

As previously discussed (see our April 6, 2012 posting), the recently enacted Jumpstart Our Business Startups Act (JOBS Act), permits an “emerging growth company” (generally, a pre-IPO company with annual gross sales of less than $1 billion) to submit a draft of its IPO (or pre-IPO) registration statement for confidential non-public review and comment by the SEC. Because the normal EDGAR filing process is not confidential, the SEC initially provided for submission of these draft registration statements in paper copy or on CD. The SEC has now updated its confidential filing procedures to provide for filing by secure e-mail of a searchable pdf copy of the registration statement using the SEC’s secure e-mail system. The e-mail filing must include a transmittal letter that identifies the issuer and the type of submission, and confirms the issuer’s status as an emerging growth company. The new procedures (available here) became mandatory on May 14, 2012, and replace the prior procedures.

The purpose of the confidential filing procedure is to allow pre-IPO companies to begin pursuing an IPO without fear of becoming “damaged goods” if, as can frequently be the case, market conditions later require them to cancel or delay their IPO. Interestingly, at least one emerging growth company, SolarCity, recently issued a press release to announce that it had made a confidential filing and planned to go public when the review process was complete.

Posted on Thursday, May 3 2012 at 9:00 am by

SEC Guidance on JOBS Act Accumulating

The SEC is currently collecting its informal JOBS Act guidance here.

The guidance posted to date includes:

  • FAQs on “emerging growth company” status and Exchange Act registration/deregistration;
  • A warning that the crowdfunding exemption is not currently available, pending SEC rulemaking (we note that general solicitation in connection with Rule 506 private placements is not available yet either, also pending SEC rulemaking); and
  • Guidance and FAQs on confidential draft pre-IPO registration statement submissions by emerging growth companies (see our April 6, 2012 posting).
Posted on Monday, April 30 2012 at 9:00 am by

ABA Federal Regulation of Securities Committee Comments on JOBS Act

The ABA Committee on Federal Regulation of Securities submitted a comment letter in response to the SEC’s invitation for comments on JOBs Act rulemaking prior to the SEC’s publication of formal rule proposals. The letter addresses the elimination of general solicitation and general advertising restrictions in connection with Rule 506 and Rule 144A transactions and can be found here.

Comment 2 is the most interesting, which is: 

“In setting forth the reasonable steps to be taken to verify that purchasers of the securities offered by means of general solicitation or general advertisement in Rule 506 offerings are accredited investors, the proposed rules should reflect current custom and practice.”

The translation is that issuers should not be required to ask for tax returns or balance sheets or do anything more than current practice when verifying accredited investor status, which is to ask the purchaser to check the box indicating how accredited status is achieved (and not to have information indicating that this claim is not true). Interesting how the authors take great care not to expressly say that.

Posted on Tuesday, April 24 2012 at 9:00 am by

The JOBS Act: What to Expect from the Not-So-Private Private Placement Regulations

One of the most significant provisions of the Jumpstart Our Business Startups Act (the “JOBS Act”), which was signed into law by President Obama on April 5, 2012, is the removal of the prohibition on general solicitation and advertising for securities offerings made pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (“Rule 506 Offerings”) – so long as sales are made only to accredited investors.

This loosening of the most fundamental restriction on Rule 506 Offerings, which effectively takes the “private” out of “private placement”, is expected by many to have a much greater impact on small business capital formation than the headline-grabbing crowdfunding provisions of the JOBS Act. This is because the crowdfunding provisions only allow for relatively small offerings and impose a fairly complex and potentially burdensome regulatory scheme. The elimination of advertising prohibitions for Rule 506 Offerings, on the other hand, is a simple change with immediate impact because it will allow for Rule 506 Offerings to be broadcast to an unlimited number of investors for an unlimited amount of money so long as sales are made only to accredited investors.

Many unanswered questions remain regarding how the Securities and Exchange Commission (the “SEC”) will amend its regulations governing Rule 506 Offerings. The JOBS Act amendments to Rule 506 Offerings will not take effect until implemented by SEC rulemaking, which the statute directs the SEC to adopt within 90 days. However, the SEC staff is currently inundated with implementing regulations regarding the provisions of the JOBS Act that were effective upon its enactment. SEC action on the provisions of the JOBS Act that are only effective upon further SEC rulemaking, such as the elimination of the advertising ban on Rule 506 Offerings, are likely to be delayed. In addition, the substantial SEC rulemaking backlog resulting from the Dodd-Frank Act (not to mention the statement by SEC Chairman Schapiro prior to enactment of the JOBS Act that many of the rulemaking timelines in the JOBS Act would “not be achievable”), make it clear that the 90-day rulemaking deadlines in the JOBS Act will be extremely difficult for the SEC staff to meet.

The following are some of the Rule 506 Offering-related issues that we would like the SEC to address in its rulemaking:

Could One Non-Accredited Buyer Destroy the Exception? The statute states that all purchasers of the Rule 506 Offering must be accredited investors; but, in the next sentence, mandates that the SEC’s rules require the issuer to take “reasonable steps to verify that purchasers of the securities are accredited investors”. It is unclear whether the SEC will permit any flexibility from the literal reading of the statute that all investors must, without exception, be accredited investors. Many believe that the applicable standard for reliance upon the new Rule 506 Offering rule should be that the issuer “reasonably believes” that all investors in the offering are accredited investors, despite the fact that the plain language of the statute does not seem to provide any room for error. Unfortunately, it is not clear that the SEC has the authority to implement this view, even if it were so inclined.

What Constitutes “Reasonable Steps” to Verify that Investors are Accredited Investors?The JOBS Act requires the SEC’s amendment to Rule 506 to address what constitutes reasonable steps to verify accredited investor status. A big question is whether the SEC rules will change the existing practices of private placement issuers in determining that their purchasers are accredited investors. Private placement issuers have traditionally sought little more than a representation from the buyer that he, she or it qualifies as an accredited investor under one or more definitions, with no further information being required. In a context where potential purchasers may have been secured by broad advertisements on the Internet and have no prior relationships with the issuer, the SEC may require some greater amount of information regarding a potential investor’s financial condition – but how much more, if any, information is a big unknown.

Will There be Two Types of Rule 506 Offerings? The new regime may result in two types of Rule 506 Offerings – one where general solicitation is allowed but sales can only be made to accredited investors, and another where general solicitation is prohibited but sales can be made to up to 35 non-accredited investors (the existing Rule 506). It is unclear whether the new rules will require issuers to elect between the two types of offerings in advance, or whether issuers will be allowed to take the most favorable position after the offering. This has led some to question whether the SEC may ultimately eliminate the safe harbor for Rule 506 Offerings made to non-accredited investors.

Will Rule 506 Offerings be Integrated with Crowdfunding Offerings?There is language in the crowdfunding provisions of the JOBS Act suggesting that crowdfunding offerings should not be considered as one offering, i.e., “integrated”, with Rule 506 Offerings even if they occur at the same time. But this language is far from clear, which raises a major uncertainty because the two types of offerings have inconsistent requirements. Rule 506 Offerings must be sold only to accredited investors, while a crowdfunding offering would likely sell to many (if not mostly) non-accredited investors. A crowdfunding offering must be conducted through a financial intermediary, which is not required for a Rule 506 Offering and in many cases would not be done. The result is that these two types of offerings are effectively mutually exclusive. Without clarification in the upcoming SEC rules that they are not to be integrated, issuers might have to space these types of offerings at least six months apart to take advantage of the existing integration safe harbor. This result would decrease the usefulness of the two new means of private capital raising in the JOBS Act.


Although the JOBS Act directs the SEC to amend Rule 506 within 90 days, existing rules will remain in effect until they are amended by the SEC. Kilpatrick Townsend will provide further updates regarding Rule 506 Offerings and other aspects of the JOBS Act on an ongoing basis as more information becomes available.

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