capital raising in us: do’s and don’ts on solicitation ......capital raising in us: do’s and...

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Capital Raising in US: Do’s and Don’ts on Solicitation Activities for Australian Fund Managers

AIMA Australia Education Forum– Sydney, Australia (February 2016)Presented by Peter J. Bilfield, Partner, Shipman & Goodwin LLP

www.shipmangoodwin.com

BACKGROUND ON RULE 506(B) SAFE HARBOR FROM REGISTRATION

Key Elements of Conducting a Private Offering in the United States

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Private Placements

• General Rule: Each Offer and Sale Must be Registered with SEC, Unless Exempt Includes sale and resale Applies to securities previously sold in registered offering

• Statutory Exemption: Section 4(a)(2) of Securities Act -Transactions by an issuer not involving any public offering Case law driven (some uncertainty) No federal preemption for Section 4(a)(2) offerings

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Safe harbor under Regulation D• Regulation D Safe Harbors: 3 Rules Providing Safe Harbor Exemption

from Registration Requirement Rule 504 and 505 Exemptions have, among other things, significant

capital raise size limitations ($1 million and $5 million, respectively) and are not “covered securities” under Section 18 of Securities Act, thus not exempt from state blue sky registration laws

Rule 506 is most widely used (approx. 99% of capital raised under Reg. D from 2009-2012) – See SEC Division of Economic and Risk Analysis Study July 2013

► No dollar limitation

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Rule 506 – Key Elements• Explanation of Safe Harbor: Deemed not to be transactions involving

any public offering

• Key Elements: Must satisfy terms and conditions of Rules 501 and 502 Rule 501 - US investors must be “accredited investors”

► Unlimited number (See Rule 501(e) for definition and calculation of number of purchasers) – issuer must reasonably believe investor falls into AC categories at time of investment

► Up to 35 Non-Accredited Investors – subject to public reporting disclosure under Rule 502

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Rule 506 – Key Elements (continued) Rule 502 – (1) sales made as part of same Reg D offering must meet all

terms of Regulation D; (2) neither issuer nor anyone acting on its behalf may offer/sell securities by form of general solicitation or general advertising; and (3) Issuer takes reasonable care to assure purchasers are not underwriters within Section 2(a)(11) of Act

► Reasonable Inquiry – Investors are purchasing for own account and not distributing to other persons

► Notice to investors/ legend on certificates – Securities not registered under Securities Act and may not be resold unless registered or exempt

Issuer will file a Form D with the SEC within 15 days of first closing

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Rule 506 – Bad Actor• “Bad Actor” Disqualification: Issuer complies with requirements of

Rules 506(d) and (e) otherwise the Safe Harbor not available. No safe harbor if any “covered persons” have engaged in certain “disqualifying events” (U.S. scienter based securities violations – look back 5 or 10 years) Covered Persons – issuer, directors, officers and other participants in offering

and GPs of issuer, promoters, 20% beneficial owners who have voting power and/or investment power and solicitors (and their officers, directors, etc.)

• Disqualifying events prior to Sept. 23, 2013: Requires timely written disclosure but will not prevent issuer from relying on 506 if it did not know and in the exercise of reasonable care could not have known about disqualifying event

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Rule 506 – Bad Actor (continued)• Practice Tips

Create matrix of relevant issuer participants in offering who must complete bad actor questionnaire

Secure and execute 20% beneficial owner/participant questionnaires Verify no pre Sept. 2013 violations Annual bring-downs for continuous offerings

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WHAT COMMUNICATIONS CONSTITUTE A GENERAL SOLICITATION


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A General Solicitation Background• Rule 502(c) provides that “…neither the issuer nor any person acting on its

behalf shall offer/sell securities by any form of general solicitation or general advertising, including, but not limited to: (1) any advertisement, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and (2) any seminar or meeting whose attendees have been invited by any general solicitation or general advertising…” Limitations apply to brokers or anyone else involved in effort to sell securities Pre-existing relationship needed - general communications to investors only

where issuer has a pre-existing relationship sufficient to enable investment qualifications (established through series of no-action letters)

• Seminal Case for determining General Solicitation - Lamp Technologies Inc.

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GS Background (continued)• Seminal Case for determining General Solicitation - Lamp Technologies Inc.

(May 1997) Lamp Technologies Inc. – No enforcement action for posting

information relating to private funds on its website (password protected) – not a general solicitation if:

► Accredited investor questionnaire on website – generic and did not reference specific funds posted on website;

► Website available only after issuer made determination investor was accredited; and► Potential investors could purchase securities after 30 day waiting period

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General Solicitation (continued)• Pre-Existing Relationship

In CGI Capital, Inc., SEC Interpretive Release No. 7904 (September 29, 2000)the SEC staff determined CGI willfully violated Section 5 of the Securities Act because securities it offered were not registered or exempt from registration.

► Staff found CGI did NOT have a PER with certain individuals it contacted CGI Capital had solicited numerous individuals via email. CGI failed to determine whether the individuals it contacted were sophisticated or

accredited investors. Messages sent by CGI contained a link to its website, which navigated to a password-

protected site that allowed users to view an online offering presentation. Password to view the offering materials provided to each recipient of the email, but there

was no warning or restriction that prevented recipients from forwarding the password to others

Offer of Settlement – cease and desist from violating Section 5 and pay $25K fine

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ESTABLISHING PRE-EXISTING RELATIONSHIPS


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Establish a Pre-Existing Relationship • Issuer who has Pre-existing Relationship with Offeree: Several no action letters

provide that such relationship would not contravene General Solicitation prohibition under Rule 502(c)

► The question of “[w]hether an issuer has sufficient information to evaluate, and does in fact evaluate, a prospective offeree’s financial circumstances and sophistication will depend on the facts and circumstances.” Citizen VC, Inc., SEC No-Action Letter (August 6, 2015)

• Establishing the Pre-Existing Substantive Relationship Issuer or agent must have a pre-existing personal or business relationship Issuer or agent in a position to assess whether investor has knowledge and experience to

make investment Issuer or agent in a position to form reasonable belief that investor meets eligibility

requirements under Regulation D and offer is personally directed to investor

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Establish a PER (continued)• Citizen VC, Inc. No Action Letter

Facts: A VC firm created policies and procedures to establish a PER with investors over the internet

► Established online VC investment platform► Investors admitted to site were pre-qualified and accredited► Password protected portions of site for offering documents and had

to fill out questionnaire

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Establish a PER (continued)• Citizen VC, Inc. No Action Letter

Facts: After vetting questionnaires, Firm engaged in a “relationship establishment period”

► connecting with the prospective investor offline to discuss such investor’s investment experience and sophistication;

► utilizing third party credit reporting services to confirm the investor’s identity and to gather additional financial information; and

► fostering offline and online interactions with the investor to answer questions about the website, the venture capital firm and potential investments. No specific time period for relationship period Firm relationship with new members pre-exists offering of securities

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Establish a PER (continued)

Citizen VC, Inc. No Action Letter• SEC concluded Firm policies for establishing pre-existing relationship over

password protected website worked and there was no general solicitation• Quality of relationship between issuer and investor most important factor to

determine substantive relationship exists – evaluate sophistication, financial circumstances and ability to understand risks

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Establish a PER (continued)• Using a Broker-Dealer

Firm can solicit current clients for whom it has current information regarding qualification under Rule 506

Non-customers who prior to the offering have been pre-screened as qualified through contacts or questionnaires

• Matching Services General Solicitation limitations do not extend to internet-based matching

services if they satisfy statutory and regulatory qualifications• Through Agents - PER

Issuer’s Agents, attorneys, accountants, consultants can be referral sources so long as they have necessary knowledge of offeree’s qualifications

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RECENT SEC STAFF GUIDANCE ON GENERAL SOLICITATION


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Highlights of SEC Staff Guidance• Pre-existing Relationship

Checking the box on investor suitability is not sufficient to create a substantive relationship

Relationship must be established prior to the consummation of an offering Prior to guidance, a waiting period of 30 days was required before accepting

subscriptions to ensure pre-existing relationship New Guidance eliminates 30 day waiting period

► Still applies to offerings for private funds relying on Section 3(c)(1) or (7)• Who can form PER

In addition to brokers, RIAs can form PERs with offerees that are a client of the RIA Other third parties (depends on facts)

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Highlights Staff Guidance (continued)• Angel Investor Networks

Networks share information and may introduce issuers to investors within network

Staff concluded issuer introduced through member network to angel investor may be able to rely on PER with members of network to establish a reasonable belief other offerees have requisite experience and sophistication

► Staff cautions – greater number of persons lacking financial sophistication contacted by issuer through impersonal means, more likely SEC will find general solicitation

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Highlights Staff Guidance (continued)• Factual Business Information can be widely disseminated

General business information – on the issuer, its business, financial condition, products, services or advertisements of such products

Can’t be presented in a way that would constitute an offer of securities – can’t condition the public re: a securities offering

Will not be deemed factual business information if it includes predictions, projections, forecasts or opinions on valuation of a security or past performance for open ended fund

• Publicly Available Website Unrestricted, publicly available website is a general solicitation if it contains an

offer of securities

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MITIGATION AND COMPLIANCE STRATEGIES


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Mitigation and Compliance• General Solicitation

There is no substantial compliance defense under Rule 508 [Insignificant deviations from a term, condition or requirement of Reg D]

No cure under federal law for conducting a general solicitation► Could convert offering to a Rule 506(c) – verifying accredited investor status of

investors (but can’t have non-accredited investors)► Isolate investor and prevent them from purchasing securities

Rescission offering with interest and transaction costs► Terminate offering and undertake a new offering 6 months later

• Policies and Procedures to avoid General Solicitation Maintain records of each communication (oral or written) with investors Number offering materials sequentially and place offeree name on cover to track a

specific offeree

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Mitigation &Compliance (continued)• Policies and Procedures to avoid General Solicitation

Include restrictive legends on all offering materials Obtain reps from investors that they are eligible to participate and understand risks Educate personnel on sales process and require pre-clearance from officer familiar with

Rule 506 requirements before soliciting US persons Refrain from using forms of mass mailing Refrain from listing any offering materials on issuer’s website, unless password

protected and restricted to “pre-screened” accredited investors Refrain from engaging in marketing-related or offering activities through social media Consider using the services of a registered broker/dealer when sourcing and soliciting

U.S.-based targets

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QUESTIONS?

Thank you.

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capital raising in us: do’s and don’ts on solicitation ......capital raising in us: do’s and...

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