[Continued from Private Placement Basics – Part I]
Due Diligence and the Suitability of Private Placements
The SEC’s recent amendments to Regulation D in accordance with the JOBS Act do not diminish a firm’s responsibility to conduct adequate due diligence on its offerings to ensure that any recommendations made to potential investors to purchase securities in a private placement are suitable. Additionally, as private placement sales activities continue to be among FINRA’s list of regulatory hot topics, FINRA will examine firms’ private placement activity to determine if firms are taking reasonable steps to confirm that investors meet accredited investor standards.
A contingency offering is a private placement in which the actual closing or sale of securities in the private placement is contingent upon a specified event occurring, typically the receipt of subscription agreements for a minimum investment amount by a certain expiration date.
As mentioned above, Rule 5123 requires that firms file offering documents that were used to sell the private placement, and that this filing must be made within 15 calendar days of the date the firm makes the first sale of securities in the private placement. In the case of contingency offerings, this raises the question of whether the date of first sale refers to when investors submit their money or when escrow is broken. In such cases, FINRA applies the standard set forth by the SEC in “SEC Release 33-8891”:
“the date of first sale is the date on which the investor is irrevocably contractually committed to invest, which, depending on the terms and conditions of the contract, could be the date on which the issuer receives the investor’s subscription agreement or check.”
Firms participating in contingency offerings should make sure that they familiarize themselves with the relevant SEC rules, including Rules 15c2-4 and 10b-9 under the Securities Exchange Act of 1934.
Disciplinary History vs. “Bad Actor” Provision
The Form asks whether any of the following people has been the subject of SEC, FINRA, or state disciplinary actions or proceedings, or criminal complaints, within the last 10 years: the issuer; any officer, director, or executive management of the issuer; any office, director, or executive management of the sponsor, the general partner, the manager, the advisor, or the issuer’s affiliates. The criteria of “Covered Persons” or “Disqualifying Events” that the SEC adopted in its “Bad Actor” Provision are not relevant to the disciplinary history question on the form. The disciplinary history question is used to assist FINRA in prioritizing its reviews of private placements, not to screen offerings for compliance with SEC requirements.
The SEC amendments in accordance with the JOBS Act permitting general solicitation for certain offerings under Rule 506 of Regulation D do not eliminate the filing requirements. Whether general solicitation is used to market a private placement is irrelevant to whether the offering must be filed pursuant to FINRA Rule 5122 or 5123.