Financial Services Reform: What It Means for Regulation D Private Placement Offerings

21 July 2010 Publication
Authors: Terry D. Nelson

Legal News Alert: Private Equity & Venture Capital

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2009 (Reform Act) was passed by Congress and signed into law by President Obama on July 21, 2010. There are certain aspects to this legislation that will impact those who offer and sell securities through private placement offerings pursuant to Regulation D under the Securities Act of 1933 (Act), as amended, including most preferred equity financings.

Minimum Net-Worth Standard for Accredited Investors

The most immediate aspect is the change to the minimum net-worth standard for accredited investors as that term applies to natural persons and is defined under Rule 501(a)(5) of Regulation D of the Act. Currently, the definition allows for a natural person to include the value of his or her primary residence or the primary residence held jointly with his or her spouse in the calculation of net worth to meet the $1,000,000 requirement. The Reform Act’s provisions eliminate the primary residence from the net-worth calculation effective as of July 21, 2010, the date the Reform Act was enacted. In addition, beginning one year after its enactment, the Reform Act requires the SEC to undertake a review of the definition of accredited investor as it applies to natural persons to determine if there are any other net-worth standards that should be adjusted or modified for the “protection of investors, in the public interest, and in light of the economy.” Upon completion of such review, the SEC may, by notice and comment rulemaking, make additional adjustments to the net-worth standard.

The SEC also is directed to conduct further reviews of the definition of an accredited investor beginning four years after the date of enactment of the Reform Act and then once every four years thereafter to determine whether the requirements of the definition should be further adjusted or modified.

No Grandfathering Provision

Importantly, the Reform Act does not provide a grandfathering provision for the application of the revised net-worth calculation. In addition, there is no indication at this point that the SEC will provide relief by rule so that issuers who have already started a private placement offering under Regulation D prior to the enactment of the Reform Act will be able to continue and complete the offering without regard to the revised net-worth standard.

Steps to Take

Accordingly, issuers that have commenced Regulation D offerings prior to the enactment of the Reform Act should adopt the revised net-worth requirement for those individual investors who subscribe to the offering after the effective date and for those investors who purchase additional securities in the offering on or after the effective date.

Attorneys currently preparing offering documents for issuers in connection with a proposed Regulation D offering should revise the accredited investor representation to be made in the subscription agreement by natural persons to reflect the revised net-worth standard.

“Bad Boy” Provisions

Another less immediate aspect under the Reform Act that will impact Regulation D offerings is the likely application of the so-called bad boy provisions to Rule 506 offerings. These provisions currently only apply to issuers and promoters of Rule 505 offerings under Regulation D. The bad boy provisions disqualify an issuer from relying upon the Regulation D exemption if the issuer or the promoter of the offering has been previously convicted of a felony or misdemeanor in connection with the purchase or sale of any security or in connection with a false filing with the SEC or if the issuer or promoter is barred from association with regulated entities or from engaging in the business of securities, insurance, banking, or in savings association or credit union activities due to fraud, manipulation, or deception. The SEC has been given one year from the enactment date to issue rules concerning such bad boy provisions to be applied to private placement offerings conducted under Rule 506 of Regulation D. As a result, it is not yet known when these provisions will begin to apply to Rule 506 offerings.

Further Analysis and Clarification

As we have more information concerning the date the bad boy provisions will apply to issuers and promoters of Rule 506 offerings under Regulation D, we will summarize that development and provide our analysis in an upcoming Legal News Alert.

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues.

If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individual:

Terry D. Nelson
Madison, Wisconsin


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