As a result of new rules issued by the SEC on July 10, 2013, companies engaging in certain private offerings will be permitted to seek potential investors through broad publicity and advertising efforts, making it easier for companies to identify investors and raise capital. This relief applies only to private offerings conducted pursuant to Rule 506 of Regulation D (the most widely used exemption under the Securities Act of 1933), so long as all purchasers are accredited, and to transactions effected pursuant to Rule 144A.

The new rules also provide that the Rule 506 exemption will no longer be available in cases where the company or certain associated persons have had certain "bad actor" disqualifying events. These bad actor disqualification rules will apply to all Rule 506 offerings, whether or not the company engages in a general solicitation. The new rules will be effective September 23, 2013. Until that date, companies should not engage in general solicitation or general advertising in connection with their Rule 506 or 144A offerings.

Lifting the Ban on General Solicitation—Rule 506 Offerings

Currently, Rule 506 prohibits general solicitation and general advertising, and companies historically have relied primarily on their own and their placing agents' existing relationships and contacts for identifying potential investors. The new rules, adopted as required under the JOBS Act, lift those restrictions. Companies will now be able to make public announcements about their offerings, such as through the Internet or social media, thereby greatly expanding the pool of potential investors and the opportunities to raise capital. In order to do so, however, all purchasers in an offering must be, or the company must reasonably believe they are, "accredited" investors, and the company must have taken "reasonable steps" to verify that such purchasers are accredited investors.¹

Verifying accredited investor status. Engaging in a general solicitation while relying on Rule 506 will require a company to take reasonable steps to verify the accredited status of each purchaser in its offering. What is "reasonable" in any transaction will require an objective determination based on the facts and circumstances of each purchaser and the offering. While the new rules do not mandate specific objective tests or steps a company should take to verify the accredited status of institutional investors, the SEC did provide a non-exclusive list of ways to determine the accredited status of individual investors, including:

• reviewing copies of any IRS form that reports income (e.g., W 2, Form 1099 or a copy of a filed Form 1040);

• reviewing copies of bank or brokerage statements for proof of total assets and a credit report for proof of total liabilities;

• obtaining written confirmation from brokers, investment advisers, attorneys or accountants that the investor is accredited; or

• obtaining a written certification from a current individual investor (who invested as an accredited investor before the effective date of the new rules) that he or she remains an accredited investor for any subsequent offering in which he or she may participate.

In addition to the documentation above, companies should continue to obtain customary representations and warranties for private placement transactions.

Key considerations. Companies relying on the new publicity relief should consider the following:

• Companies should retain adequate records. In addition to subscription documents and investor questionnaires typically obtained from investors, companies will need to retain records of any written correspondence with investors related to their accredited status, including any representations or certifications, and documentation of their income or net worth.

• Verification methods for institutional investors may differ. Methods to verify the accredited investor status of partnerships, LLCs, corporations and other entities and institutions (e.g., banks, investment companies, trusts and employee benefit plans) will depend on the category and nature of the organization. In certain cases, their accredited investor status will be easily verifiable or apparent, while in other cases documentation and processes similar to what is expected to be used for individual investors may be warranted.

• Verification process could deter potential investors. Certain accredited investors may be unwilling to provide the sensitive financial information contemplated by the examples of verification processes noted by the SEC.

• Verification process not required where no general solicitation or advertising is used. Companies that can raise the desired level of capital without relying on general solicitation may seek to take that route and avoid the more intrusive verification process, relying instead on customary representations and questionnaires from investors.

• Engaging in a general solicitation may limit a company's flexibility in completing the current and future offerings. Companies should understand that once they engage in a general solicitation, they are effectively ruling out participation by non-accredited investors or completing the transaction under the traditional private placement exemption under Section 4(a)(2) of the Securities Act. This inability to sell the offered securities to non-accredited investors or fall back on the traditional private placement exemption could apply for an extended period (likely six months under a conventional integration analysis). In addition, under a conventional integration analysis, a general solicitation may impair the availability of the traditional Rule 506 and private placement exemptions (including the ability to sell to non-accredited investors) for near-term future offerings.

• Proposed further amendments to private offering rules may discourage companies from using, and dilute the benefit of, the new rules. The SEC currently is seeking comments on proposed rules that would require a company seeking to use general solicitation in a private placement offering to: (1) file an advance notice of sale 15 days before (and at the conclusion of) the offering before it could engage in general solicitation; (2) include certain legends and disclosures in any written general solicitation materials; and (3) submit to the SEC through a confidential filing any written general solicitation materials that will be used.

• Anti-fraud rules continue to apply. The SEC's anti-fraud rules still apply to any communication, whether written or oral, to prospective investors.

Lifting the Ban on General Solicitation—Rule 144A Offerings

Under the new publicity rules, Rule 144A has been amended to allow for offers to persons other than qualified institutional buyers, or "QIBs," including by means of general solicitation, provided that the securities are sold only to investors that the seller reasonably believes are QIBs.

"Bad Actor" Disqualification under Rule 506

The new rules prohibit a company from relying on the Rule 506 exemption if the company or certain persons associated with the company or the offering have been subject to certain disqualifying events. Only disqualifying events that occur after the effective date of the final rules will disqualify a company. However, companies will be required to disclose to prospective investors in a Rule 506 offering any disqualifying events that occurred within specified time frames before the effective date of the final rules.

Disqualifying events. Events that will disqualify companies from relying on the Rule 506 exemption include, among other things, criminal convictions, court injunctions and orders arising from conduct in securities transactions; certain SEC disciplinary orders; and SEC cease-and-desist orders related to unregistered sales of securities or anti-fraud violations, as well as certain other orders by federal and state banking, securities and insurance regulators.

Covered persons. Only disqualifying events experienced by a company (including its predecessors and affiliated companies) or by any of the following persons within the time frames specified by the rule will disqualify the company from relying on Rule 506:

• directors, executive officers, other officers that participate in the offering, general partners and managing members of the company;

• beneficial owners of 20% or more of the company's voting securities;

• promoters connected to the company;

• investment managers and directors and principals of investment managers of pooled investment funds issuing the offered securities; and

• persons compensated for soliciting investors, such as placement agents and finders, as well as directors, executive officers, other officers that participate in the offering, general partners and managing members of any compensated solicitor.

Reasonable care exception. The new rules provide an exception from disqualification if a company can demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a covered person was subject to a disqualifying event. The rules do not, however, prescribe specific steps that companies must take to establish "reasonable care" other than that it should be a factual inquiry into whether any disqualifications exist, which may vary from company to company.

Key considerations. Companies seeking to rely on Rule 506 for private offerings should begin to prepare for the effectiveness of the new disqualification rules, including the following:

• Determine whether any disclosable disqualifying events exist. Companies should diligence their directors, executive officers, 20% stockholders and other covered persons to determine the need to disclose any disqualifying event occurring prior to the effective date of the new rules.

• Obtain certifications. A company should seek certifications from finders, placement agents or any other third parties compensated for soliciting investors and/or negotiate representations and covenants into engagement letters or placement agency agreements in order to support the company's exercise of "reasonable care."

• Consider updating D&O questionnaires. The list of bad actor disqualification events under the new rules differs from the list of bad actor activities required to be disclosed in annual reports or proxy statements pursuant to Item 401 of Regulation S-K. Accordingly, public companies in the private placement market may wish to update their annual director and officer questionnaires to incorporate the bad actor disqualification events. Confirming the absence of disqualifying events also should become part of any company's review of prospective director nominees and new officer hires.

• Consider the impact of disqualifying events in accepting significant new investments. Companies should consider the impact of disqualifying events and undertake the necessary due diligence with respect to new investors whose ownership of the company potentially may exceed 20% post-transaction.

¹ Generally, individuals with annual incomes of at least $200,000 for the last two years and similar expectations for the current year, or a minimum net worth (not including their primary residence) of $1 million, are "accredited investors," as are certain entities.