Yesterday, the U.S. Securities and Exchange Commission (SEC) enacted a rule as part of the Jumpstart Our Business Startups Act, or JOBS Act, which lifts the ban on general solicitation and marketing for investment funds and Rule 144A securities offerings. The change means that these once private offerings can now be broadly marketed as long as they are only sold to appropriate investors.
We wrote about the potential for this rule change to be passed, and the ramifications it would have for the ILS and catastrophe bond markets, last year in April and then again in August. It has taken the SEC almost a year to get to the stage of enacting the proposed rule change due to its far-reaching consequences.
The rule change was adopted by a 4 to 1 vote and lifts the restrictions on advertising securities offerings that have been in place for some 80 years. This means that issuers of private offerings can now raise funds and find investors through more broad marketing and solicitation practices.
For investment funds, this lifts restrictions which have meant historically that outfits such as hedge funds including insurance-linked securities (ILS) and reinsurance-linked investment funds, had to be very careful about their marketing to ensure that they only solicited to what the SEC terms accredited investors.
For Rule 144A securities offerings, which includes catastrophe bonds and ILS issuances, the marketing of these deals has always been behind closed doors by bookrunners who directly approach only what the SEC terms Qulaified Institutional Buyers (QIB’s).
With the ruling yesterday the SEC has changed this for both funds and 144A securities, which has ramifications for the markets we cover. The approval by the SEC of the JOBS Act requirement to lift the ban on general solicitation now means that both funds and securities can be broadly marketed, place an ad in the newspaper or here on Artemis for your latest cat bond offering or your ILS hedge fund, just so long as the investors in the fund or buyers of securities are correctly accredited or qualified.
The onus is now on the issuer or offering party of an investment opportunity or security to ensure that its investors and buyers are correctly accredited or qualified. This actually won’t be a huge burden for those offering or running a book on a deal, as QIB’s are fairly easy to identify and accredited investors will be made to prove their ability to invest at those levels.
In connection with this ruling, the SEC has also voted to issue a rule proposing that issuers provide additional information about their securities offerings which will enable the SEC to more effectively monitor the market with the ban on general solicitation now lifted.
Of course, being an SEC ruling this only applies to securities offerings and marketing of funds or 144A’s to U.S. markets, but given that the bulk of the ILS and cat bond investor market is currently U.S. based this is potentially a big deal and levels the playing field for those seeking to market such investment opportunities.
“As we fulfill our mission to facilitate capital formation and maintain fair and efficient markets, the Commission must always focus on strong investor protections,” said Mary Jo White, Chair of the SEC. “We want this new market and the private markets in general to thrive in a safe and efficient manner, and these rules we adopt and propose are designed to facilitate that objective.”
Now this isn’t quite law yet, although we’re fairly sure that general solicitation of many securities offerings will change from today, the ruling is set to undergo a 60 day public comment period after its insertion in the Federal Register before the amendments become effective.
For the markets we cover this means that U.S. domiciled ILS funds and third-party capital managers can now talk openly about fundraising, even market their offerings and talk about success in raising new funds, something they haven’t done to date. For catastrophe bond issuers, this means that they can talk about their offerings in advance, even advertise them in an appropriate place where the audience is made up of potential investors and also communicate more clearly about the ambitions of a cat bond in terms of size and other factors.
Of course, the market may choose to continue to run closed books on cat bonds and ILS and reinsurance investment or hedge funds may not feel the need to market their services more broadly. But this does make life a little easier for new entrants to the fund space, who can raise their profile in front of relevant audiences through marketing and solicitation. It also means that cat bonds can go directly up against each other to attract investors if they so choose, by advertising the relative benefits of their transaction over another.
The SEC’s amendments to the general solicitation ban are a welcome modernisation of our capital markets and will have ramifications far beyond the ILS and reinsurance markets. As such they are being welcomed by many sectors, such as start-ups, investments, funds, securities and venture capital. The changes are detailed on the SEC website here and the main ruling which was passed yesterday can be found below.
Rule 506The final rule approved today makes changes to Rule 506 to permit issuers to use general solicitation and general advertising to offer their securities provided that:
- The issuer takes reasonable steps to verify that the investors are accredited investors.
- All purchasers of the securities fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
Under existing Rule 501, a person qualifies as an accredited investor if he or she has either:
- An individual net worth or joint net worth with a spouse that exceeds $1 million at the time of the purchase, excluding the value (and any related indebtedness) of a primary residence.
- An individual annual income that exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
The determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each purchaser and the transaction.
Nevertheless, in response to commenters’ requests, the final rule provides a non-exclusive list of methods that issuers may use to satisfy the verification requirement for individual investors.
The methods described in the final rule include the following:
- Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
- Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited status.
The existing provisions of Rule 506 as a separate exemption are not affected by the final rule. Issuers conducting Rule 506 offerings without the use of general solicitation or general advertising can continue to conduct securities offerings in the same manner and aren’t subject to the new verification rule.
Under the final rule, securities sold pursuant to Rule 144A can be offered to persons other than QIBs, including by means of general solicitation, provided that the securities are sold only to persons whom the seller and any person acting on behalf of the seller reasonably believe to be QIBs.
The final rule amends Form D, which is the notice that issuers must file with the SEC when they sell securities under Regulation D. The revised form adds a separate box for issuers to check if they are claiming the new Rule 506 exemption that would permit general solicitation or general advertising.
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