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Private Placements

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Topics to Be Discussed • One Year Later

• Rule 506(b) versus Rule 506(c)

• Bad actor guidance • How have practices developed? • C&DIs • Waivers

• Investor Verification and other Rule 506 Developments • CFTC Relief for Funds • What’s on the Horizon?

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One Year Later

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Statistics and Anecdotal Reports • According to the SEC, since the effective date, fewer than 10% of the

offerings and less than 5% of capital raised – approximately $10 billion – is in 506(c) offerings

• Crowdnetics provides one full year of data: 942 successful 506(c) offerings completed

• Matchmaking portals have been focusing largely on Rule 506(b) “accredited investor” crowdfunding

• Rule 506(b) accredited investor crowdfunding largely relies on pre-JOBS Act SEC guidance (Lamp no-action letter and its progeny)

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Concerns That Have Emerged • Until recently, the CFTC had not provided guidance regarding its

rules and that prevented hedge funds and other funds from relying on 506(c)

• Concerns from angel investors and others regarding investor verification and sharing personal information

• The SEC has continued to state its intention to take action on the proposed amendments to Regulation D, Form D and Rule 156

• Stigma associated with Rule 506(c)?

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Bad Actor Rules

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Covered Persons • The amendment added a new Section 506(d) to Regulation D. • This new section encompasses disqualification provisions that are

substantially similar in their effect to the bad actor disqualification provisions that are currently codified in Rule 262 of Regulation A.

• The provisions are applicable only in the context of Rule 506 offerings, regardless of whether general solicitation is used.

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Covered Persons (cont’d) • The disqualification provisions apply to the following “covered

persons”: • The issuer and any predecessor of the issuer or affiliated issuer; • Any director, executive officer, other officer participating in the offering process,

general partner, or managing member of the issuer; • Any beneficial owner of 20% or more of any class of the issuer’s voting equity

securities, calculated on the basis of voting power; • Any investment manager to an issuer that is a fund and any director, executive

officer, or other officer participating in the offering, general partner, or managing member of the manager, as well as any director, executive officer or officer participating in the offering of any such general partner or managing member;

• Any promoter connected with the issuer in any capacity at the time of the sale; • Any person that has been or will be paid, directly or indirectly, remuneration for

solicitation of purchasers in a securities offering (a “compensated solicitor”); or • Any director, executive officer, other officer participating in the offering, general

partner, or managing member of such compensated solicitor.

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Disqualifying Events • The rule includes the following categories of disqualifying events:

• Criminal convictions; • Court injunctions and restraining orders; • Final orders of certain state regulators (such as securities, banking, and insurance)

and federal regulators; • The CFTC was added to the list of regulatory agencies; • A definition of “final order” was added to Rule 501.

• SEC disciplinary orders relating to brokers, dealers, municipal securities dealers, investment advisers, and investment companies and their associated persons;

• Certain SEC cease-and-desist orders; • Suspension or expulsion from membership in, or suspension or barring from

association with a member of, a securities self-regulatory organization (“SRO”); • SEC stop orders and orders suspending a Regulation A exemption; and • U.S. Postal Service false representation orders.

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Reasonable Care Exception • The rule contains a reasonable care exception, which applies if an

issuer can establish that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed because of the presence or participation of a covered person.

• Issuer would need to conduct a factual inquiry; the SEC notes that the type of inquiry will depend on the facts and circumstances.

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Waivers • The rule permits the SEC to grant waivers upon a showing of good

cause. • The rule does not articulate standards for granting waivers. • The adopting release lists various circumstances that might be

relevant to a waiver, such as a change of control, a change of supervisory personnel, absence of notice and an opportunity for hearing, and a relief from a permanent bar for a person who does not intend to apply to reassociate with a regulated entity.

• Waivers may also be granted by the SEC upon written advice from the issuing authority.

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Addressing Bad Actor Rules • For issuers:

• Updated D&O questionnaires • Representations in securities purchase agreements

• For broker-dealers: • New provisions in engagement letters and securities purchase agreements • Internal procedures to collect the requisite information from bankers

• Certifications • Periodic updates

• Inconsistencies between FINRA reportable events, events that need to be reflected in Form ADV and disqualifying events under bad actor rules

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SEC Guidance • The SEC has issued three sets of C&DIs that provide clarity on a

number of issues • An “affiliated issuer,” for purposes of Rule 506(d), is an affiliate (as defined in

Rule 501(b)) of the issuer that is issuing securities in the same offering, including offerings subject to integration pursuant to Rule 502(a).

• Persons whose sole involvement with a Rule 506 offering is as members of a compensated solicitor’s deal or transaction committee that is responsible for approving such compensated solicitor’s participation in the offering are not “participating” in a Rule 506 offering, for purposes of Rule 506(d)(1).

• Actions taken in jurisdictions other than the United States, such as convictions, court orders, injunctions in a foreign court, or regulatory orders issued by foreign regulatory authorities will not trigger a disqualification under Rule 506(d).

• Rule 506(e) does not mandate disclosure of past events that would no longer trigger a disqualification under Rule 506(d), such as a criminal conviction that occurred more than ten years prior to an offering or a bar that is no longer in effect at the time of the offering.

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SEC Guidance (cont’d) • A shareholder that becomes a 20% beneficial owner of the issuer’s voting equity

securities upon completion of the sale of securities in a Rule 506 offering is not a 20% beneficial owner at the time of the sale, for purposes of determining who is a covered person with respect to that offering.

• The term “beneficial owner,” as used in Rule 506(d), is interpreted the same way as under Rule 13d-3 under the Securities Exchange Act of 1934; beneficial ownership includes both direct and indirect interests, determined as under Rule 13d-3. Consequently, one must look through entities to their controlling persons.

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SEC Guidance (cont’d) • If there is 20% beneficial ownership of the issuer’s voting equity securities by

shareholders that have formed a group, the disqualification or disclosure obligations will apply to triggering events that apply only to the group itself, assuming that no member of the group is a 20% beneficial owner. Here, the SEC used the example of a group being formed by means of a voting agreement. If any party to the voting agreement has or shares power to vote or direct the vote of shares beneficially owned by other parties to the agreement, then beneficial ownership of such shares will be attributed to that party. In those circumstances, one would look not only at the group itself, but also through the group to the parties to the voting agreement and determine whether any such party is a 20% beneficial owner due to such aggregated voting power and whether that party is subject to a disqualification event.

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Open Questions • For broker-dealers, the frequency of obtaining certifications • For funds and funds-of-funds, a number of questions remain

regarding ownership attribution • Waiver requirements or standards

• The SEC has granted various bad actor waivers • Process for bad actor waivers is different from the process for granting other

waivers

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Rule 506

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Reasonable Steps to Verify Investor Sales • The final rule retains the proposal’s principles-based guidance,

highlighting that the inquiry to be undertaken may differ depending on the facts and circumstances. The SEC provides a list of factors to consider:

• The nature of the purchaser. The SEC describes the different types of accredited investors, including broker-dealers, investment companies or business development companies, employee benefit plans, and wealthy individuals and charities.

• The nature and amount of information about the purchaser. “The more information an issuer has indicating that a prospective purchaser is an accredited investor, the fewer steps it would have to take, and vice versa”.

• The nature of the offering. The nature of the offering may be relevant in determining the reasonableness of steps taken to verify status, i.e., issuers may be required to take additional verification steps to the extent that solicitations are made broadly, such as through a website accessible to the general public, or through the use of social media or e-mail.

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Reasonable Steps to Verify Investor Sales (cont’d)

• The final rule does not provide for a safe harbor; however, it does set out a supplemental non-exclusive list of methods that may be used to satisfy the verification requirement, including:

• A review of IRS forms for the two most recent years and a written representation regarding the individual’s expectation of attaining the necessary income level for the current year;

• A review of bank statements, brokerage statements, tax assessments, etc. to assess assets, and a consumer report or credit report from at least one consumer reporting agency to assess liabilities;

• A written confirmation from a registered broker-dealer, RIA, CPA, etc.; • For existing investors (pre-506(c) effective date), a certification.

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Investor Verification • SEC Staff has provided some limited guidance on various of the

non-exclusive methods • Industry group, like SIFMA, have provided guidance to supplement

the principles based approach but perhaps much of this is aimed at larger broker-dealers

• Practices are still being formulated

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CFTC Guidance

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CFTC Relief • The Dodd-Frank Act amended the definition of a “commodity pool,”

making it substantially broader and eliminating certain exemptions • As a result, many funds that “trade” in swaps were required to register

with the CFTC/NFA as “commodity pools” and become subject to the registration, compliance and ongoing regulatory requirements

• There are some exemptions still available, such as the de minimis exemption

• Under 4.13(a)(3) a commodity pool must meet one of two alternative tests concerning the limited size of its commodity interest positions, among other requirements, and could not engage in marketing to the public and avail itself of this exemption.

• Following changes to Rule 506, it was unclear whether a fund could claim the de minimis exemption and engage in general solicitation (be it a Rule 506(c) offering or Rule 144A transaction)

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CFTC Relief (cont’d) • Regulation 4.7 provides limited relief to registered CPOs from

certain disclosure, reporting, and recordkeeping requirements. • Regulation 4.7(b) provides that such relief is available only to

• A registered CPO who offers or sells participations in a pool solely to qualified eligible persons in an offering that qualifies for an exemption from the registration requirements of the Securities Act pursuant to Section 4(a)(2), as amended by the JOBS Act, or Regulation S, or

• Any bank registered as a CPO in connection with a pool that is a collective trust fund whose securities are exempt from registration under the Securities Act pursuant to Section 3(a)(2) and are offered or sold, without marketing to the public, solely to qualified eligible persons.

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Scope of CFTC Relief • Exemptive relief only addresses 4.13 and 4.7 for CPOs that are

relying on the JOBS Act and using general solicitation or general advertising

• Relief requires the CPO to affirmatively notify the CFTC and provide a representation, but is then immediately effective upon filing

• Information to be provided to the CFTC: • Basic information regarding the CPO and the commodity pool for which the claim

is filed; • A statement as to whether the CPO claiming the relief is relying on Rule 506(c) or

is using resellers under Rule 144A; and • A statement as to whether the CPO intends to rely on CFTC Regulation 4.7 or

4.13(a)(3) with respect to the commodity pool, as well as a representation that the CPO meets the remaining requirements of the relevant Regulation.

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Limitations of the Relief • The Relief addresses only two sections (4.7 and 4.13) and does not

amend those regulations, nor does it address other CFTC rules and regulations

• The Relief does not address CTAs • The Relief requires a fund to state that it is conducting an offering • The Relief does not address the verification process for investors

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Proposed Amendments to Private Offerings

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Form D • The proposed rule would require issuers to file (a) an advance

notice of sale 15 days before and (b) at the conclusion of an offering • Currently, issuers selling securities in Rule 506 offerings must file Form D no later

than 15 calendar days after the first sale of securities in the offering. • As proposed, issuers that intend to engage in a Rule 506 general solicitation

would also be required to file Form D at least 15 calendar days before the general solicitation.

• Issuers would be required to update Form D within 30 days of completion of filing.

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Form D (cont’d)

• The proposed rule would require issuers to provide additional information about the issuer and the offering.

• Currently, Form D requires identifying information about the issuer and related persons, the exemption relied upon, and other facts.

• As proposed, issuers must provide additional information: • Identification of issuer’s website • Expanded information on the issuer • Offered securities • Types of investors in the offering • Use of proceeds from the offering • Information on types of general solicitation used • Methods used to verify accredited investor status of investors

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Form D (cont’d) • The proposed rule would disqualify issuers who fail to file Form D.

• Issuers would be disqualified from using Rule 506 exemption in any new offering if the issuer or its affiliates did not comply with the Form D filing requirements.

• Disqualification would continue for one year, beginning after the required Form D filings are made.

• Cure period available for late Form D filing. • For national banks, 12 C.F.R. Part 16.7 does not require a Form D filing.

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Solicitation Materials • The proposed rules would require issuers to include legends and

disclosures in written solicitation materials. • Rule 509 would require Issuers to include legends or cautionary statements in

written general solicitation materials used in Rule 506 offerings. • Legends intended to inform potential investors that offering is limited to

accredited investors and may involve risks.

• Failure to include legends and disclosures required by Rule 509: • Required legends or other disclosures would not be a condition of Rule 506(c)

exemption. • Failure to include Rule 509 legends or other disclosures in any written general

solicitation materials would not make Rule 506(c) unavailable for the offering. • Instead, Rule 507 provides that Rule 506 would not be available if the issuer (or

its predecessors or affiliates) is subject to an order, judgment or injunction resulting from failure to comply with Rule 509.

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What’s on the horizon? • Congressional action and other developments

• Various bills have been introduced that would: • Create an “angel investor” definition that would provide an alternative to

verification • Update various private offering exemptions, and codify 4(a) (1-1/2)

• Various Congressmen have written to the SEC to express their concerns regarding the proposed Regulation D amendments

• NASAA and consumer advocates have continued lobbying for Regulation D amendments and for changes to the accredited investor definition

• Move forward with its “accredited investor” study • Proceed with some amendments to Regulation D although we

anticipate that the final rules will be quite different from the proposed rules