I recently attended a two day Regulation D conference sponsored by the American Bar Association. The Panel consisted of current and former SEC, FINRA and blue sky regulators, sharing their thoughts on the latest trends in private placements and Regulation D offerings. The following are various topics discussed during the seminar.
SEC Proposed Amendment to Regulation D
In December 2006, the SEC proposed significant changes to Regulation D, including the creation of a new category of “large accredited investors” and use of limited advertising for such investors. The consensus of the panel was that the SEC Proposal will simply die on the vine and will not be adopted, certainly not in its current form.
FINRA – Increased scrutiny of Member Firms conducting Private Placements
A variety of topics were discussed during this portion of the Seminar, but with a common theme – FINRA will be paying more careful attention to member firms conducting private placements, with particular emphasis on member firm’s due diligence investigation of issuers whose securities they are placing, and the suitability of the investors in the transactions. Specifically:
- In its review of member firms, FINRA will be examining the quantity and quality of due diligence under taken by member firms. It is expected that due diligence will be properly documented and will cover areas such as background of management; prospects of the issuer’s business; review of issuer’s assets; and review of historical information. It was also emphasized that a member firm doing a follow on offering for a an existing corporate finance client cannot simply rely on a prior due diligence file; to the extent necessary, the ‘older’ file needs to be updated with new information concerning the issuer.
- Tying into the due diligence obligations of member firm are issues of suitability of the private placement issuer’s securities for clients of the member firm. Specifically, this falls into two categories – (i) reasonable basis suitability; that is, based on a member firm’s due diligence investigation of an issuer, are the securities of that issuer suitable for the investor; and (ii) specific suitability – is the investment suitable for the investor based on his or her investment objectives. It was emphasized that merely being an ‘accredited investor’ who is eligible to participate in a Regulation D offering does not, in and of itself, mean that the investment is suitable for that particular investor.
Use of Finders – No solutions in sight
While the consensus of the panel is that finders, and the role they play, are ultimately beneficial for the capital raising process, particularly with smaller issuers, it nevertheless appears that the various proposals that have been suggested (so called –broker dealer ‘lite’) while not necessarily being rejected by the SEC out of hand, are certainly not a priority item for the Staff at the current time. While a number of states – notably Texas – have created the concept of a “registered finder,” the use of finders remains an area of concern for regulators, particularly at the state level. One, a finder could find himself/ herself as the subject of an enforcement action as a unregistered broker-dealer; and two, use of an unregistered broker-dealer typically gives rise to an automatic right of rescission by an investor under state blue sky law, even if there are no other substantive issues arising out of the private placement. As one former regulator said, using a finder means you are selling ‘one year puts.’