In an earlier post, we commented on some considerations for issuers and their advisers in respect of offerings made in reliance on Rule 506 after September 23, 2013.  Broker-dealers that are serving as financial intermediaries or placement agents in connection with private offerings also should plan ahead and take into account that, with the effective date of the changes to Rule 506, documentation and compliance and other practices may need to be revisited.  The following highlights some of the considerations for broker-dealers:

  • Financing plans:  at the outset of an engagement, the broker-dealer will want to discuss with the company and agree on the desired approach, which may involve an offering made in reliance on the Section 4(a)(2) statutory private placement exemption (not involving the use of general solicitation), an offering made in reliance on Rule 506(b) (not involving the use of general solicitation), or an offering made in reliance on Rule 506(c) (permitting the use of general solicitation).  The discussion of financing alternatives may involve a detailed overview of the company's financing activities in the months prior to the proposed offering (which might reasonably be integrated with the proposed offering) as well as the company's financing objectives generally.  The company's funding plans should be considered as a whole in order to determine the most appropriate structure for the proposed offering.
  • Engagement letter:  based on the financing alternative, the broker-dealer may want to implement specific changes to its form engagement letter.  The broker-dealer may want to identify specifically the exemption being relied upon, and, to the extent that general solicitation will be used, the broker-dealer may want to specify in the engagement letter the types of communications that will be used, and require that communications be agreed between the parties, and the responsibilities for the communications.
  • Purchase agreement or placement agency agreement:  the broker-dealer also may want to review and revise their forms of purchase agreement and/or placement agency agreement to address Rule 506 and bad actor issues.  See our earlier post regarding proposed provisions.
  • Relationship with prospective investors:  the broker-dealer will want to consider whether it will be approaching only investors that are current clients of the broker-dealer (with whom the broker-dealer has a pre-existing relationship, and as to whom the broker-dealer has undertaken a know-your-customer and suitability inquiry), or whether it will approach, or the issuer will approach, investors with whom the broker-dealer does not have an existing relationship.  The broker-dealer will nonetheless need to follow its established know-your-customer, suitability, AML and other processes in respect of prospective investors that are not pre-existing customers.
  • Investor verification:  if general solicitation will be used, will the broker-dealer be responsible for undertaking the verification process, or will a third party be engaged?
  • Diligence:  FINRA has long been focused on the Regulation D market and has reminded broker-dealers of their diligence obligations in respect of private offerings, including in Regulatory Notice 10-22.  It is important to keep in mind that private offerings will be under close scrutiny.
  • Compliance Considerations:  the broker-dealer also will have to keep in mind that, although we're entering into a new world of general solicitation, existing FINRA and other rules and regulations remain in effect, including, the following:
  • FINRA know-your-customer and suitability obligations:  the broker-dealer must still undertake all of the steps it would ordinarily undertake in connection with selling or recommending investments to customers;
  • AML and other requirements:  either the broker-dealer or a third party will have to undertake necessary steps;
  • Communications rules:  under FINRA Rule 2210, most communications that would be used in connection with a general solicitation would be considered a "retail communication" and, therefore, subject to review, filing and recordkeeping requirements;
  • Private offering requirements:  under FINRA Rule 5123, the broker-dealer will be required to make certain filings with FINRA, and may be required to file offering materials;
  • Social media use:  the broker-dealer will want to ensure that those employees involved in the offering are familiar with the firm's social media policy.  In the context of an offering using general solicitation, the broker-dealer should understand how the company will use social media (if at all), and how its own employees may be pulled into certain social media communications;
  • Bad actor rule:  the bad actor rule also will become effective on September 23rd.  This means that broker-dealers involved in private offerings will have to ensure that they have undertaken an analysis of whether any employees involved in these offerings are affected by the rule.  See our earlier post on the bad actor disqualifying events compared to the events that are required to be disclosed on Forms U-4/U-5; andForeign regulations:  the broker-dealer should also consider that, while a general solicitation may be permissible in the United States, selling restrictions and limited offering exemptions may still be applicable in foreign jurisdictions.
  • Issuer education:  the broker-dealer may want to spend additional time discussing with the company and management the issues that they may want to consider in connection with undertaking a private offering or an offering using general solicitation, the types of general solicitation that may be used, whether written general solicitation should be used, the messaging and the individuals responsible for communicating on the company's behalf, and the types of purchasers that are desirable investors for the company.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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