HomeNewsArticles Private Placements: Selected Exemption and Disclosure Issues After the JOBS Act (as of June 10, 2016)
For more information please read,Information for the Small Businessperson Considering Selling Securities (After Enactment of the JOBS Act in 2012)or watch a recent presentation by the authorhere.
The following article provides an overview of the basic private offering and resale exemptions and safe harbors available to issuers and investors under the Securities Act of 1933 (the Securities Act) after the enactment of the JOBS Act on April 5, 2012. The private offering exemption in particular has increasingly been used for offerings of novel or complex securities and during times of market downturns and market uncertainties. The JOBS Act made significant changes possible in the use of the exemptions and safe harbors discussed in this article; final regulations implementing the private placement aspects of the JOBS Act were adopted on July 10, 2013, and were effective on September 23 2013.
The term public offering is not defined in the Securities Act. The contours of the non-public offering exemption have been established by interpretations of the Securities Act by the Securities and Exchange Commission (the SEC) and the courts.
In Securities Act Release No. 33-285 (January 24, 1935) the SEC indicated that the following four factors should be considered in determining whether an offering is public:
The number of offerees and their relationship to each other and to the issuer. The focus is on the number of offerees, not the actual purchasers. The basis on which the offerees are selected and the relationship between the issuer and the offerees are significant. An offering to the members of a class who should have special knowledge of the issuer is less likely to be a public offering than an offering to the same number of persons who do not have that advantage.
The manner of offering. Transactions which are effected by direct negotiation by the issuer are more likely to be considered non-public than those effected through the use of the mechanisms of public distributions.
Absent an exemption from registration, every securities transaction that uses the U.S. mails or other means of interstate commerce must be registered with the U.S. Securities and Exchange Commission. The most common issuer exemptions under the Securities Act are the following:
Of these, the issuer private offering exemptions are:
Section 4(a)(2) of the Securities Act, which provides a statutory exemption for transactions by an issuer not involving any public offering.
Rule 506(b) of Regulation D, which provides a safe harbor for an issuer engaged in a non-public offering to persons who may or may not be accredited.
Rule 506(c) of Regulation D, by which Congress provided a new exemption for an issuer engaged in general advertising to accredited investors only.
The issuer must [in the Section 4(a)(2) or Rule 506(b)] demonstrate that the offering (a) meets the requisite offeree/purchaser qualification requirements and informational requirements, (b) should not be integrated with another exempt or registered offering, (c) does not [in Section 4(a)(2) or Rule 506(b)] involve any general solicitation or advertisement, and (d) includes appropriate resale restrictions. Effective September 23, 2013, the new exemption Rule 506(c) under the JOBS Act permits general advertising and general solicitations. Rule 506(c) is discussed below under III. General Solicitation Issues After the JOBS Act.
The securities issued and sold to purchasers are so-called restricted securities. There are at least six ways for investors to resell in a single transaction the restricted securities received in a private placement:
register the securities (e.g., in the public equity side of a PIPE transaction);
sell the securities directly to qualified institutional buyers (QIBs) pursuant to SEC Rule 144A (which was amended by the SEC to comply with the JOBS Act);
resell the securities through an offshore transaction pursuant to the resale provisions of SEC Regulation S;
sell the securities to the public in a transaction not involving a distribution as defined by SEC Rule 144;
sell the securities pursuant to the SEC Rule 144(k) (fully available to non-affiliates after one (1) year); and
sell the securities in a 4(a)(1 and 1/2) transaction.
Hereinafter all regulations and rules are as promulgated by the Securities and Exchange Commission unless otherwise indicated.
I.Section 4(a)(2) and Rule 506(b) Requirements
Section 4(a)(2) and Rule 506 are limited to offerings by an issuer; resales by underwriters and affiliates of an issuer must rely on another exemption.
Limited to persons capable of fending for themselves. See
, 246 U.S. 119 (1953) (Ralston Purina). In
the Supreme Court addressed the Section 4(a)(2) exemption [then it was Section 4(2)]. It remains the only Supreme Court interpretation of this exemption.
Unlike the earlier SEC Release, the Court did not focus on the quantity of offerees involved but instead focused on the quality of those persons. The Court stated that nothing prevents the [SEC], in enforcing the statute, from using some kind of numerical test in deciding when to investigate particular exemption claims. But there is no warrant for superimposing a quantity limit on private offerings as a matter of statutory interpretation.
The Court stated that the design of the [Securities Act] is to protect investors by promoting full disclosure of information thought necessary to informed investment decisions… [T]he applicability of [4(a)(2)] should turn on whether the particular class of persons affected needs the protection of the Act.
The Court noted that an offering to persons who are shown to be able to fend for themselves is a transaction not involving any public offering. In determining whether a person is capable of fending for himself, the Court appeared to be concerned with whether the offeree (1) had access to the kind of information which registration would disclose and (2) was financially sophisticated.
, 440 F.2d 631, 633 (10th Cir. 1971), the Court of Appeals limited the private offering exemption to include only persons of exceptional business experience, and [those in] a position where they have regular access to all the information and records which would show the potential for the corporation. In
, 463 F.2d 137 (5th Cir. 1972), the Court of Appeals required the issuer to prove that each offeree had a relationship with the issuer giving access to the kind of information that registration would have disclosed. In
, 545 F.2d 893, 903 (5th Cir. 1977), the Court of Appeals determined that access to information about the issuer can be provided either through direct disclosure to the offeree or by means of effective access through family relationship, employment or economic bargaining power.
Need to ensure that the offering is made to accredited investors and not more than thirty-five (35) sophisticated yet unaccredited investors.
The definition of accredited investor is outlined in Rule 501(a). The concept of accredited investor is critical in the private offering context, both from the standpoint of establishing an exemption for the offers and sales and in determining the required level of disclosure as discussed below. An accredited investor means any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:
a bank, insurance company, registered investment company, business development company, or small business investment company;
an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decision, or if the plan has total assets in excess of $5 million;
a charitable organization, corporation, or partnership with assets exceeding $5 million;
a director, executive officer, or general partner of the company selling the securities;
an entity in which all the equity owners are accredited investors;
a natural person who has individual net worth, or joint net worth with the persons spouse, that exceeds $1 million at the time of the purchase (and, effective on July 22, 2010, this net worth cannot include the value of the persons primary residence or the mortgage or debt secured by the primary residence if the amount of that debt is
than the fair market value of that residence);
a natural person with income exceeding $200,000 in each of the two most recent years of joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
a trust or other entity with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
Neither Section 4(a)(2) nor Rule 506(b) (other than the thirty-five (35) sophisticated unaccredited investor limit) contains any numerical caps on the number of offerees and purchasers. The general solicitation prohibition and market practice typically set the outer parameters. General solicitation and general advertising are not defined in Rule 506(c). However, in other contexts, these have been defined to include advertising offerings through the Internet (including via social media and email), newspapers, magazines, television, seminars, and radio.
Section 4(a)(2) and Rule 506(b) contain informational requirements. If a disclosure obligation exists, the information must be provided to the offeree prior to the time of sale.
Each offeree must possess or have access to the type of information that would be included in a registration statement and which would enable the offeree to make an informed investment decision. In
, 679 F.2d 1323 (9th Cir. 1982), the Court of Appeals focused on both quantity and quality of offerees and stated that the private offering exemption under Section 4(a)(2) depended on the number of offerees, their sophistication, the size and manner of the offering and the relationship of the offerees to the issuer. In holding that Sorrell failed to meet his burden that the sale of 16 limited partnership interests was exempted from registration, the Court of Appeals noted that access by the offerees to financial information about the investment, similar to what would be found in a registration statement, would be crucial. At trial, Sorrell offered no evidence of the number of offerees and no evidence of the information they received. Such information generally should include information concerning the issuers business, financial condition, results of operations, property, and management.
(i) There are no informational requirements for accredited purchasers. The rationale is that these investors are sophisticated and have sufficient bargaining power to obtain all relevant information from the issuer. However, SEC Rule 10b-5, promulgated pursuant to the Securities Exchange Act of 1934 (the Exchange Act), which imposes liability for material misstatements or omissions, still applies to sales of securities to all offerees, including these accredited investors.
(ii) Each non-accredited purchaser (i.e. the 35 sophisticated investors) must receive certain information, which varies based on the nature of the issuer and the size of the offering.
: Must provide each purchaser with certain non-financial information and with specific types of financial statement information depending upon the size of the offering. This is most often with reference to the dictates of the Model Circular of Part II of Regulation A. See Rule 502(b). Note that the Model Circular is revised effective June 19, 2015.
Reporting companies must furnish the same disclosure, regardless of offering size. Such information may either be:
(a) An issuers most recent annual report to shareholders that meets the requirements of Exchange Act Rule 14a-3 (which specifies the information required to be delivered in connection with proxy solicitations) or Rule 14c-3 (annual report information requirements delivered in non-proxy solicitations prior to an annual meeting or other shareholder meeting), the definitive proxy statement filed in connection with that annual report, and, if requested in writing, the issuers most recent Form 10-K.
(b) The information contained in the issuers most recent annual report on Form 10-K or a Form 10 under the Exchange Act or a Form S-1 under the Securities Act. Under this option, the actual form documents need not be delivered because the relevant rule refers to the information contained in the forms, not the forms themselves.
An issuer is obligated to update and supplement any such disclosures with additional information and must provide disclosures regarding material changes in the issuers affairs that are not covered in documents furnished to purchasers.
Financial statements of foreign private issuers may be prepared using U.S. generally accepted accounting principles (U.S. GAAP) or non-U.S. GAAP statements, provided the statements are reconciled with U.S. GAAP.
D. Bad Actor Limitations Upon Issuers Who Want to Use Rule 506(b) or Rule 506(c)
Section 926 of the Dodd-Frank Financial Reform Act required the SEC to adopt rules which would make Rule 506 unavailable for securities offerings in which certain felons and other bad actors are involved. On July 10, 2013 the SEC adopted final rules in this regard effective September 23, 2013.
The new bad actor rules are set out in paragraph (d) of Rule 506. Under the new rule, the involvement of covered persons who are the subject of disqualifying events disqualify securities offerings from exemption underbothRule 506(b) and Rule 506(c).
The following persons, among others, are covered persons:
The issuer and any predecessor or affiliate issuer
Any director, executive officer, or officer participating in the offering
Any beneficial owner of 20% or more of the issuers voting securities
Any promoter connected with the issuer at the time of sale
Any investment manager of a pooled fund issuer
Any placement agent or compensated solicitor in the offering
The following types of events, among others, are disqualifying events:
Criminal convictions in connection with the sale of a security or a false filing with the SEC, or arising out of the conduct of an underwriter, broker-dealer, investment adviser, or placement agent within the last ten years
Court injunction or restraining orders with regard to the foregoing persons or activities within the last five years
Final orders of certain state (such as securities, banking and insurance) regulators, federal regulators, and the CFTC
SEC disciplinary orders relating to SEC regulated persons
U.S. Postal Service false representation orders
The rule includes a reasonable care exception if the issuer can establish that it did not know, and, in the exercise of reasonable care, could not have known, of the disqualifications. Also, an issuer may seek a waiver of the disqualification if the issuer shows good cause and the SEC determines that it is not necessary under the circumstances that an exemption be denied.
The doctrine is intended to prevent issuers from circumventing the registration requirements of the Securities Act and is used to determine whether:
two or more purportedly discrete exempt offerings are really one offering that does not qualify as an exempt offering, or
an exempt offering is really part of a registered public offering.
Securities Act Release No. 33-4552 (Nov. 6, 1962) sets forth the five factor test that is used as a guideline in determining whether or not the separate offerings of an issuer that occur within a short time of one another will be integrated. The same factors are in the Note to Rule 502(a) of Regulation D. The factors considered are:
(a) whether or not the offerings are part of a single plan of financing;
(b) whether the offerings involve the issuance of the same class of securities (convertible securities, warrants, and other derivative instruments generally are deemed to be the same class as the underlying security unless the terms of the primary security prohibit exercises until at least the one year anniversary date);
(c) whether the offerings are made at or about the same time;
(d) whether the same type of consideration is to be received; and
(e) whether the offerings are made for the same general purpose.
Practitioners should also consider a sixth factor: Are the offerees in each offering of the same class or character?
The five factor test has not brought certainty to the area because its application is subjective and the staff has not provided definitive guidance as to what weight to give to the various factors or indeed how many of them have to be met.
However, there is no guidance as to how many of the five factors must be satisfied. In
, the staff stated that it considered the two most important factors to be (a) whether the financings constituted a single plan of financing, and (b) whether the offerings were for the same general purpose.
NABA Sports Corp.; North American Baseball Association, Inc.
(avail. Sept. 9, 1987), the staff considered whether simultaneous offerings of different securities by the same issuer were to be treated as part of the same offering. The staff concluded that a Rule 504 offering of Class A common stock to raise start-up money need not be integrated with a Rule 506 offering of options to purchase Class B common stock made to selected investors to solicit interest in becoming team owners in the baseball league. The staff stated that the offerings appeared to involve different securities because the Class B common stock will be non-transferable, have liquidation preference and contain a limited forfeiture provision and the offerings appeared to be for different purposes.
(avail. May 3, 1988), the staff determined that a public offering of common stock and preferred stock did not need to be integrated with a private placement of notes and common stock purchase warrants made less than six (6) months later. The staff concluded that the offerings appear to involve different classes of securities (the common stock purchase warrants were not exercisable and generally were nontransferable for a period of five (5) years), and the offerings appear to be for different purposes and involve different plans of financing. The proceeds of the note and warrant offering were to be used for acquisitions.
(avail. Oct. 25, 2001), the staff found that a proposed demutualization converting the company from a mutual insurance company into a stock insurance company and the distribution of common stock in connection with the demutualization should not be integrated with a coincident IPO. The staff, in applying the five factor test, found that the demutualization and the IPO were not part of the same plan of financing nor were the offerings made for the same general purpose. The two events had two (2) separate goals: the demutualization to provide the company with greater financial flexibility and the IPO to raise capital for the Company.
See also The Prudential Insurance Company of America
Rule 502(a) provides that multiple private offerings that are conducted at least six (6) months apart will not be integrated; also, a private offering that is conducted at least six (6) months before or after a registered or exempt public offering will not be integrated with the public offering.
Rule 152 and staff interpretations provide that an otherwise valid private placement will not be integrated with a subsequent registered public offering.
The closing date for the private offering may occur after filing of the registration statement so long as all closing conditions, other than customary conditions such as no material adverse change, are outside the control of the private investors.
, the SEC stated that, pursuant to Rule 152, a private placement is completed on the date the agreement to purchase securities is signed provided the purchasers obligations are binding and subject only to satisfaction of conditions that are not within the purchasers control. In
, the SEC cautioned that the position taken in its Black Box no-action letter is limited to unregistered offerings made to Rule 144A qualified institutional investors and no more than two or three large institutional accredited investors.
Rule 155 Safe Harbors for Abandoned Private and Public Offerings (Release No. 33-7943, effective Mar. 7, 2001) [as amended February 27, 2012]
The Rule creates safe harbors to allow (i) a public offering immediately following an abandoned private offering and (ii) a private offering thirty (30) days after an abandoned public offering, without integrating the public and private offerings in either situation. These safe harbors provide issuers with more flexibility to react to volatile capital market conditions.
The safe harbors will not be available if the Commission finds that transactions, while technically in compliance, are part of a plan or scheme to evade the registration requirements of the Securities Act.
Rule 155 does not replace the traditional integration analysis and in that respect, the traditional five factor test will be used whenever the safe harbor specifications are not met.
Rule 155 does not address whether two or more private offerings should be integrated with each other. The traditional five factor test would apply to this scenario.
Rule 155 recognizes only Sections 4(a)(2) and 4(a)(5) (which exempts transactions not exceeding $5 million if offers and sales are made only to accredited investors as defined in Section 2(a)(15) of the Securities Act and Rule 215 and if certain other conditions are met) and Rule 506 offerings as exempt offerings.
Rule 155 is not available for shelf registration statements.
The Rule 155(b) safe harbor for abandoned private offerings is available if:
no securities were sold in the private offerings;
the issuer or its intermediary terminates all offering activity in the private offering before the issuer files the registration statement (proof of which the Commission has encouraged the staff to monitor closely to avoid abuse of Rule 155(b));
any prospectus filed as a part of the registration statement discloses information about the abandoned private offering including (a) the size and nature of the private offering, (b) the date on which the issuer terminated all offering activity in the private offering, (c) that any offers to buy or indications of interest in the private offering were rejected or otherwise not accepted, and (d) that any prospectus delivered in the registered offering supersedes any selling materials used in the private offerings; and
the issuer does not file the registration statement for a period of thirty (30) calendar days from termination of offering activity related to the abandoned private offering; there is no waiting period if offers in the private offering were made only to accredited or sophisticated investors.
Any issuer that relies on the Rule 155(b) safe harbor must first satisfy the private offering exemption (
, the private offering must be bona fide). Rule 155 defines a private offering as an unregistered offering of securities that is exempt from registration under Section 4(a)(2) or 4(a)(5) of the Securities Act or Rule 506[b?] of Regulation D. This requirement is intended to insure that the initial private offering is a serious offering by the issuer and that the issuer initially has the intention to consummate the offering when commenced.
The SEC has stated that it intends to closely monitor the use of Rule 155(b) to prevent its misuse and the Staff has the authority to request additional information from the issuer regarding the termination of all offering activity in the private placement.
Any issuer that, although in technical compliance, intends to use either of the Rule 155 safe harbors as a plan or scheme to evade the registration requirements under the Securities Act will be denied the right to use the safe harbor. These measures are designed to insure that any gun jumping that may occur as a result of the utilization of Rule 155(b) is incidental to a bona fide private offering and not a plan to avoid the gun jumping restrictions of the Securities Act.
no securities were sold during the registered offering. (This requirement will not be met if the issuer or its intermediary received any money or other form of consideration, including escrowed monies, for the securities);
the issuer withdraws the registration statement. See Rules 477 and 478 under the Securities Act:
the issuer and its intermediary do not commence the private offering earlier than thirty (30) calendar days after the effective date of withdrawal of the registration statement;
the issuer notifies each offeree in the private offering that the offering is not registered under the Securities Act and of the consequences that accompany a private placement, which include informing the investor that (a) the securities are restricted securities that cannot be resold without registration unless an exemption is available and (b) purchasers do not have the protection of Section 11 of the Securities Act, which imposes civil liabilities on issuers on account of false registration statements; a registration statement for the abandoned public offering was filed and withdrawn;
any disclosure document used in the private offering discloses any changes in the issuers business or financial condition that occurred after the issuer filed the registration statement and that are material to the investment decision in the private offering;
The SEC has instituted several measures to prevent the use of the Rule 155(b) safe harbor to facilitate any intentional gun jumping, by which an issuer distributes offering materials and solicits offers before a registration statement is filed.
Rule 701(f) that separates out employee benefit plans;
Preliminary Note 7 to Regulation D and the note to Rule 502(a), as well as Release No. 33-6863 (Apr. 24, 1990), providing that offshore offerings under Regulation S generally will not be integrated with domestic offerings;
(avail. July 8, 2002), providing that an onshore private offering of short-term paper conducted in compliance with Rule 506 of Regulation D should not be integrated with an offshore public offering carried out under Regulation S;
Rule 144A(e), stating that resales to QIBs pursuant to Rule 144A will not affect the availability of a prior or subsequent exempt offer or sale by an issuer or investor;
Rule 147s six month intrastate offering safe harbor;
Rule 155(c) safe harbor for abandoned public offerings is available if:
Under Rule 155(c), general solicitations occurring prior to the commencement of a 30-day cooling-off period do not affect the subsequent private offering. However, the private placement must otherwise be free of general solicitations and must otherwise qualify for an exemption from registration under Section 4(a)(2) or 4(a)(5) of the Securities Act or Rule 506 of Regulation D. In the SECs view, this requirement will ensure that the private offering following the abandoned public offering is a bona fide private offering. The ban on general solicitations in private placements has not been lifted. However, in the SECs view, a 30-day cooling-off period cures the impact of impermissible solicitations.
III.General Solicitation Issues After the JOBS Act
For the SEC, a fundamental premise of a private placement has been the prohibition of general solicitation and advertising. Negotiations or conversations with or general solicitations of an unrestricted and unrelated group of prospective purchasers for the purpose of ascertaining who would be willing to accept an offer of securities is inconsistent with a claim that the transaction does not involve a public offering even though ultimately there may only be a few knowledgeable purchasers. Securities Act Release No. 33-4552 (Nov. 6, 1962).
The prohibition applies to both issuers and anyone acting on behalf of the issuer. Before the JOBS Act, Rule 502(c) precluded the use of:
any advertisement, article, notice or other communication published in any newspaper magazine, or similar media or broadcast over television or radio, and
any seminar or meeting whose attendees have been invited by any solicitation or general advertising.
To avoid engaging in a general solicitation, the Commission staff indicated that one should:
look to the existence of a substantive relationship that evidences a persons investment sophistication.
(avail. Nov. 3, 1985) (finding that broker dealers could ensure Rule 502(c) compliance by establishing a substantive and preexisting relationship with the offerees) and
The Commission does not condone the practice of investor self-certification of accreditation of sophistication prior to gaining access to a private offering.
A.No General Solicitations under Section 4(a)(2) and Rule 506(b)
Commission interpretations before the JOBS Act indicate the following:
A broker dealer or issuer using an internet website can ens