August 2012

Join us for a JOBS Act Update. The seminar will be held at The Michelangelo in New York on Friday, September 21st, from 8:15am-10:00am. Want to attend? Click here.

We invite you to join us for the first of our fall CLE series (note: new location). Our session will focus on developments related to the JOBS Act and the IPO market. We will discuss the SEC Staff’s guidance on various interpretative questions relating to Title I of the JOBS Act. We also will discuss the SEC Staff’s Frequently Asked Questions on research issues, and the proposal relaxing the ban on general solicitation in connection with certain private offerings. Our speakers will cover the following topics:

  • SEC views on emerging growth company (EGC) status;
  • Testing-the-waters;
  • Research guidance, research safe harbors, and liability issues;
  • Using Title I benefits in connection with mergers and exchange offers;
  • The general solicitation proposal and investor verification;
  • The IPO process and investor communications; and
  • Practical considerations for various offering formats, including PIPE transactions, 4(a)(1-1/2) transactions and 4(a)(2) exempt offerings.


David Lynn
Partner, Morrison & Foerster LLP

Anna Pinedo
Partner, Morrison & Foerster LLP

Tymour Okasha
Assistant General Counsel, Bank of America Merrill Lynch

NY and CA CLE credit is pending.

Now that the SEC has proposed rules to eliminate the general solicitation and general advertising restrictions for certain offerings of securities, can advertisements for private funds on bus shelters and billboards be far behind?

Not so fast.

Private funds, including hedge funds, venture capital funds and private equity funds, often rely on Section 4(a)(2) and Rule 506 safe harbors to offer interests without registering under the Securities Act of 1933.  Private funds typically rely on the exemptions from the definition of “investment company” provided by Section 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940.  As a condition to relying on these exemptions, funds cannot publicly offer their securities, which includes a prohibition on advertising.  When the JOBS Act ordered the SEC to lift this ban, it opened a Pandora’s Box.

Private funds have never been able to publically advertise, so they never had to worry about standards for general advertising in newspapers, radio, TV, the internet, billboards, buses and bus shelters, or milk box cartons.

Until now.

Once the SEC fulfills the JOBS Act mandate to unshackle the advertising chains, what will private funds do?  Will there be a rush to spend thousands, or millions, of dollars on advertising?  What rules will apply?

The JOBS Act mandate to the SEC does not refer specifically to private funds.  The SEC clarified that the when Congress directed it to allow private fund general solicitations and general advertisements, the private funds won’t lose either of the exemptions under the Investment Company Act.  That’s one compliance headache avoided.  But there’s more.

Private funds advised by registered investment advisers.  We won’t be shocked if the SEC insists that the private funds managed by registered advisers must comply with Rule 206(4)-1 under the Investment Advisers Act.  This rule regulates advertisements by registered advisers.  Among other things, it prohibits testimonials (broadly interpreted); advertisements of cherry-picked investment returns, charts or graphs soliciting investors on statistics alone, and the catch-all misleading statements or material omissions.  But if the hedge fund, not the adviser, is running the advertisement, can the SEC really force a private fund to comply with the prohibitions of Rule 206(4)-1?  We will leave that discussion for another day.

Private funds advised by unregistered advisers.  This gets a bit more complicated.  The SEC’s advertising rules apply only to registered investment advisers (and those required to be registered).  What about advisers that rely on any of the Dodd-Frank exemptions from registration, such as the adviser solely to venture capital funds, advisers solely to private funds with less than $150 million under management, and foreign private advisers?  What about investment advisers registered with a state?  While these advisers are exempt from the substantive rules of the Investment Advisers Act, some must still report to the SEC certain information on Form ADV.

On its face, these exempt advisers, and state registered advisers, do not have to comply with the substantive provisions Rule 206(4)-1.  Of course, the anti-fraud laws of the Investment Advisers Act apply to all advisers, exempt or not.  And, state laws concerning advertisements may apply.

Will the SEC adopt rules for private fund advertisements, similar to those that apply to mutual funds?  Time will tell.

To be sure, when the shackles are lifted, hedge fund advisers are advised to tread carefully, because there may be some land mines planted in the wide-open field of private fund advertising.  And remember, past results do not guarantee future performance.

Following this morning’s meeting, the Commission has published its proposed rules:


The SEC published its guidance today as a proposed rule, with a comment period, and not as an interim final rule.

The SEC proposes to amend Rule 506 to provide that the prohibition against general solicitation contained in Rule 502(c) shall not apply to offers and sales of securities made pursuant to Rule 506 provided that all purchasers are accredited investors and the issuer takes reasonable steps to verify their status.

Form D will be amended so that an issuer will be required to indicate whether it has used general solicitation.

The SEC is not proposing to amend the Section 4(a)(2) exemption.

Rule 506 offerings

Release implements a bifurcated approach—that is an issuer can conduct a Rule 506 offering without general solicitation, or a Rule 506(c) offering using general solicitation

A new Rule 506(c) is introduced, which would permit general solicitation provided:  issuer takes reasonable steps to verify investor status; purchasers are accredited investors; and other conditions of Rule 501 and 502(a) and 502(d) are satisfied.

The Staff is not prescribing a verification approach, but recognizing that the reasonableness of the steps taken to verify status will be based on particular facts and circumstances.  The Staff sets out a number of measures (in the form of a non-exclusive list) that could be used in order to assess investor status.

Rule 144A

Rule 144A will be amended to remove the reference to “offer” and “offeree” from Rule 144A(d)(1), requiring only that securities be sold only to a QIB or person reasonably believed to be a QIB.


Rule 144A/Rule 506 offerings will not be integrated with contemporaneous Regulation S offerings—however, the language used in the release may not be as clear as market participants would like.

At a meeting this morning, the SEC voted to propose rules relaxing the ban on general solicitation for certain offerings conducted pursuant to Rule 506 and resales under Rule 144A.  In a meeting that lasted approximately 45 minutes, the Staff outlined the principal aspects of the proposed rules.  The Staff indicated that it was proposing rules for comment, and not proposing an interim final rule.  As a result, market participants will have an opportunity to comment on the proposal and the Staff will have an opportunity to consider these comments prior to the adoption of final rules.  As anticipated, close attention will be required in relation to the Staff’s proposals regarding the “reasonable steps” to be taken to verify accredited investor status for offerings in which general solicitation is used.  The Staff discussed generally the verification process.  The Staff also discussed proposed changes to Form D.  The Staff also noted that the proposal would address the “directed selling effort” prong of Regulation S.  We will provide a detailed analysis of the proposal shortly.

The Commissioners provided interesting perspectives on the proposed rules and on the rulemaking process.

Commissioner Walter noted her support for modification of the communications rules in order to make these rules more contemporary.  She noted that allowing general solicitation is “a profound change,” which likely will have “unintended consequences.”  Commissioner Walter noted that comments on the proposal should help to identify these potential unintended consequences.  She also suggested that the Staff consider updating Form D in order to make it a source for more information regarding the types of offerings in which general solicitation is used and that the Staff should study the uses of general solicitation.  Commissioner Walter asked how the Staff intended to monitor the use of Rule 506 offerings involving general solicitation.  Meredith Cross noted that a multi-divisional task force would be formed in order to identify offerings in which general solicitation was used and to understand the verification processes used in these offerings.

Commissioner Aguilar noted he did not support the proposal and he would issue a separate statement which would be forthcoming.  He expressed concerns about investor protection.

Both Commissioners Paredes and Gallagher expressed their support for the proposal, while noting their significant concerns with the rulemaking process itself.  The two Commissioners noted that the original rulemaking course, which had been to release an interim final rule (not a proposal), had been changed in midstream.  This change had been occasioned after significant concerns had been expressed by various groups, including state regulators.  Both Commissioners Paredes and Gallagher noted their concern regarding the change in course and the resulting delays.

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The state securities regulators, NASAA, just recently published their list of financial products that pose investor protection concerns.  Not surprisingly given the level of rhetoric from the states, crowdfunding and internet-based offers of securities are at the top of the list of “new threats” to investors.  The state securities regulators caution that once JOBS Act provisions governing crowdfunding are finalized, the use of the internet to raise capital will become more prevalent, as will fraud.  Private offerings made in reliance on Rule 506 of Regulation D are cited as a “persistent” threat.  The statement notes that these offerings are “high-risk and may not be suitable for many individual investors.”  Interestingly, in all of the commentary on risks posed by Regulation D offerings, little effort seems to be made to draw distinctions among the types of companies using Regulation D offerings for capital raising.  Many already public companies rely on Regulation D offerings to raise capital.  Presumably, there is less concern regarding fraudulent practices in connection with these offerings.

In the most recently issued set of FAQs on the JOBS Act, the SEC Staff also addressed testing-the-waters communications, and, in particular, the requirements of Rule 15c2-8(e).  Rule 15c2-8(e) requires that a broker-dealer make available a copy of the preliminary prospectus (prior to the effective date) for a registered offering of securities before soliciting orders from customers.  If read broadly, the prohibitions of Rule 15c2-8(e) might constrain the types of activities that are permissible during test-the-waters discussions.  The FAQs provide practical guidance noting that while the JOBS Act does not amend Rule 15c2-8(e) (that is, the JOBS Act does not modify the meaning of the term “solicit”), an emerging growth company or a financial intermediary acting on the EGC’s behalf may engage in discussions with institutional investors to gauge their interest in purchasing EGC securities before the EGC has filed its registration statement with the SEC (when 15c2-8 would technically not apply) and after the EGC has filed its registration statement.  During this period, the underwriter may discuss price, volume and market demand and solicit non-binding indications of interest from customers.  Soliciting such a non-binding indication of interest, in the absence of other factors, would not constitute a “solicitation” for purposes of 15c2-8(e).  This is very helpful.  Of course, underwriters still will need to monitor carefully the types of communications that take place during test-the-waters discussions to ensure compliance with the securities laws.

On August 22, 2012, the SEC’s Division of Trading and Markets published a highly anticipated series of JOBS Act related FAQs addressing various research related matters.  The FAQs are available at  Although the FAQs are quite consistent with the views that have been expressed over the last few months by SEC Staff, it may be helpful to the compliance personnel of investment banks to have the guidance committed to writing.  The guidance confirms that for settling firms an amendment or modification of the global research settlement would be required in order for such firms to take full advantage of certain provisions of the JOBS Act.

The FAQs reiterate that JOBS Act Section 105 is intended to permit research analysts to participate in meetings with issuer management, but research analysts cannot engage in efforts to solicit banking business.  The FAQs note that a research analyst attending a meeting with investment banking colleagues could outline the firm’s research program and factors considered in the analysis of a company and ask follow-up questions of management.  After a banking firm has been retained, the research analyst could participate in sales force discussions along with company management in order to educate the sales force about trends in the industry and research’s views.  The FAQs emphasize that the objective of the JOBS Act was to eliminate burdens on the management of emerging growth companies resulting from having to take part in separate meeting with banking and with research personnel, but not to weaken any of the safeguards intended to mitigate conflicts of interest.  In this respect, the FAQs confirm that Regulation AC is not affected by the JOBS Act.

The FAQs clarify that the JOBS Act should be understood to apply to NYSE Rule 472 to the same extent as it applies to NASD Rule 2711.

The FAQs explain that the Staff views the prohibition on quiet period rules contained in Section 105(d)(2) as applying to the quiet periods on research at the termination, waiver, modification, etc. of a lock-up agreement (in connection with an emerging growth company IPO or a follow-on offering) regardless of the means by which the lock-up period comes to a close.

The FAQs are helpful; however, until the global research settlement is modified, market practice relating to research is unlikely to change much.  Market participants also likely await additional FINRA guidance, and FINRA amendments to NASD Rule 2711 and NYSE Rule 472 for emerging growth companies that will carry out the objectives of the JOBS Act.

Today, the SEC removed from the August 22nd Open Meeting agenda the  consideration of rules to eliminate the prohibition against general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act and Rule 144A under the Securities Act, as mandated by Section 201(a) of the JOBS Act.  In a separate notice, the SEC indicates that it will now consider whether to propose rule changes under Title II on Wednesday, August 29th.  The new notice clarifies that the changes to Rules 506 and 144A will be proposed, rather than published as interim final rules.

For several years, a task force within the Business Law Section of the American Bar Association has tried to get the attention of federal and state regulators to address an issue that comes up from time to time in private placements and even in an occasional public offering.  What do you do about a person who is instrumental in putting together a deal (or at least in introducing the parties) and who expects to receive some form of transaction-based compensation (i.e., “success fee”) but who is not registered as a broker or dealer with the Securities and Exchange Commission or any of the state authorities?  Although admittedly a gray area of the law, it gives securities lawyers pause when having to opine on the validity of an offering because the consequences for such a failure could possibly include a voiding of the transaction.

The task force’s latest attempt has been to draft a position paper, which has been submitted to the SEC’s Division of Trading and Markets and to certain state regulators and which was discussed at the Section’s recent annual meeting in Chicago.  The approach taken is to have the SEC adopt a rule exempting such persons from registration under the Securities Exchange Act of 1934 on the condition that they be registered with one or more states.  The proposal raises a number of questions which should be addressed in crafting such an exemptive rule (e.g., should there be a limit on the aggregate number or aggregate dollar value of transactions per year to qualify for the exemption?) and in providing for appropriate state regulation as a counterpart (e.g., will the states be encouraged to adopt a model state registration rule and, if so, how will they deal with typical licensing requirements such as net capital, fidelity bonds, qualification examinations, “bad actor” disqualifications and reports, among others?).  Although the task force makes a cogent case once again for taking up the finder issue, we do not foresee the regulators being able to deal with the matter any time soon.

F. Lee Liebolt, Jr. practices corporate and securities law in New York and can be reached at